Where Can Mexico Go?

In the old world that ended sometime last month, the peso was a king. It was among the strongest currencies in the world and appreciated against the US dollar for the past three years. It appreciated nearly 10% against the greenback, which itself was rising against most currencies.  

Mexico is poorly placed to deal with the coming economic shock. The peso has already fallen nearly 30% in the five-week slide, and the full appreciation of the tragedy is not yet discounted.  

First, consider its pre-existing condition. The economy contracted every quarter last year. The central bank kept the overnight interest rate target was among the highest real and nominal levels in the world. This, in turn, attracted carry-trade strategies by levered accounts, and asset managers liked the yields and potential for capital gain in the bond market. Speculators in the futures market had a record large gross and net long peso position. Executives may have felt relief over the new NAFTA agreement, but Mexico's President AMLO has no won over the confidence of businesses.  

Next, think about channels that the shock will impact Mexico. Roughly 40% of Mexico's GDP is exported, 80% of which is sent to the US. The dramatic slowing of the US economy, even if not as bad as St. Louis Fed's Bullard's pessimistic scenario of a 50% contraction, means pain for Mexico's businesses. Worker remittances and tourism are also significant contributors to Mexican GDP and source hard currency. These flows have dried up.  

The collapse in oil prices also does Mexico no favors. The price of WTI for May delivery has fallen from $53.50 to $22.65 in the past four weeks.  Mexico has slashed the price of is Maya benchmark as well. The government hedges oil prices but not in a comprehensive fashion.  It protects the price of about 235k barrels a day or around 20% of its exports at $49, according to press reports. At $35, 80% of Pemex output is thought to be unprofitable.  

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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