Last year we noted that the currencies to the north and south of us – the Canadian dollar and Mexican peso – were having a rough time, due primarily to the fact that oil prices were so low.
This year we have had a strange divergence. The Canadian dollar has appreciated 5 percent year-to-date while the Mexican peso has fallen by about 7 percent, with most of the drop coming over the last month.
On the face of it, this looks a bit strange.
Energy prices seem to have found a bottom, with crude bumping up against $50 a barrel this week, the first time it has been there since October. In addition, Mexico’s economy is doing fairly well, growing at about 2.5 percent last year and at a slightly higher pace this year.
More importantly, the Bank of Mexico – Mexico’s monetary authority – has kept base interest rates relatively high. In February it raised rates by 50 basis points to 3.75 percent, while here in the U.S. investors are concerned about the mere possibility of a 25 basis point hike to 0.75 percent before the end of the year.
But even with the Bank of Mexico’s interest rate increase – something that normally would attract investors – the peso enjoyed only a relatively short period of strength before weakening again. Chalk up yet another instance when a central bank’s policies fail in the face of a market determined to drive prices in the opposite direction.
So with the incentives to buy the Mexican peso high, why is it falling?
One reason is a bizarre side effect of what makes Mexico a sought-after destination for investment capital in the first place. Mexico has a pretty advanced capital market, with deep liquidity in the credit and foreign exchange markets. Such a developed market is essential to attract international capital flows.
But with investors losing faith and interest in many emerging markets, Mexico has also been the easiest place for investors from which to pull funds or go short on a currency they deem to be in an “emerging market.” That means the peso is easy to use as a proxy hedge against a downturn for investors exposed to emerging markets.
My View: I can’t really complain about Mexico offering investors a good capital market. Unfortunately markets are neither fair nor kind and Mexico is likely to continue to suffer some short-term struggles. But this is a bump on the road for a country that is developing into a world economic player.
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