I have seen a lot of movements in the Mexican peso exchange rate over the years, starting with the peso devaluation at the end of 1994 and 50% depreciation of the currency against the US dollar in 1995.
Although not quite that dramatic, the past few months have been something of a wild ride for the Mexican peso. After reaching a nine-year strong point of 16.3 pesos to the US dollar in April of this year, the peso is now hovering around 20.
It’s been a rapid weakening that has caught some by surprise after a few years of steady appreciation. So where does the peso go from here? And what should we keep an eye on?
Predicting foreign exchange movements is not an exact science, especially in the short term.
It’s important to remember that currencies move based on both economic and non-economic factors. Let’s step back for a moment and remember what the key economic drivers are that determine how one currency moves versus another.
Experts tend to look at three indicators to try to predict where one currency will go versus another: inflation rates, GDP growth rates and interest rates.
Inflation
If the inflation rate of Mexico is higher than that of the United States (as is the case currently), all else being equal, we would expect the Mexican currency to depreciate by the difference in the inflation rate between the two countries.
For example, if annual inflation is 5% in Mexico and U.S. inflation is 3%, we would expect the Mexican peso to depreciate 2% annually versus the US dollar.
Based on annual headline inflation rates, despite the fact that both Mexico and the U.S. are seeing their rates continue to decline from pandemic levels, there is still a difference of over 2 points between the two countries. This would imply that the Mexican peso will depreciate slightly versus the US dollar going forward.
GDP growth
If one country is growing faster than another, all else being equal, we would expect that country’s currency to appreciate versus the slower-growth country.
Last year, Mexico’s real annual GDP growth outpaced the U.S., at 3.2% versus 2.5%, but the latest IMF forecasts for 2024 project the U.S. economy will grow 2.6% and Mexico’s economy will grow 2.2% (though this may be optimistic based on a recent Bank of Mexico forecast). Therefore, the Mexican peso would be expected to depreciate slightly against the US dollar.
Interest rates
Currency predictions tend to be based on the movement of rates, the difference in rates between countries, and the difference between a country’s interest rates and its inflation rate, more than on the actual interest rates themselves.
For example, Mexico’s current key rate is 10.75%, while the U.S. Federal Reserve has held its benchmark rate at 5.25-5.5% since July 2023. The large difference between the two countries’ rates has attracted investor interest in the peso.
Also, the fact that Mexico’s annual headline inflation is currently at just under 5% (resulting in a relatively large difference between the interest rate and inflation rate) has strengthened the Mexican peso.
Looking backward over the past few years, when we saw appreciation in the Mexican peso, we can point to the economic factor of interest rates as one of the primary reasons the country saw an appreciation of its currency, despite higher inflation than the U.S. Some economists also point to the excitement around nearshoring having an impact.
But dramatic movements in currencies often occur due to non-economic events.
When the peso rocketed to above 25 to the US dollar in 2020, the cause was of course the COVID-19 pandemic. The recent move of the peso from around 16 to over 20 was also triggered by a non-economic event: Mexico’s elections in June and their aftermath.
Given the economic factors discussed above, we would expect the peso to continue a slow depreciation of 3-5% in the next 12 months, meaning we could see 21 pesos to the US dollar within a year.
However, it is the volatile non-economic news that will likely drive significant currency movements in the future, as has often been the case in the past.
A few examples of non-economic issues that could affect currency rates: U.S. election campaign negative rhetoric toward Mexico (likely a peso depreciation), U.S. tariff policy against Mexico (likely a peso depreciation), USMCA discussion complications (potentially a peso depreciation), or increased global tension in Ukraine or Israel (potentially a peso depreciation).
What might cause the peso to actually strengthen again?
A few examples could be the incoming Sheinbaum administration taking investor-friendly positions on renewable energy and foreign direct investment in the energy sector, increased U.S.-China tensions causing Mexico’s trade standing to improve, or improved dialogue between the incoming Mexico administration and the next U.S. administration.
Predicting currency movements is not for the faint of heart as there are many variables — both economic and non-economic — that we need to keep our eyes on to help guide our understanding.
Mexico News Daily will continue to be your front-row seat to the economic and geopolitical winds of change in Mexico.
Travis Bembenek is the CEO of Mexico News Daily and has been living, working or playing in Mexico for over 27 years.
Excellent analysis, however I would also attribute the strength of the peso over the last two days to government intervention, the central bank buying pesos to give the impression of stability.
Agreed and that will likely be temporary.
Although central banks around the world occasionally do intervene in measures to influence their own currency, I have not read anything that suggests that this in fact happened this past week. This is what MND reported earlier this week:
“The peso’s recovery has been mostly attributed to a weakening US dollar following the publication of both inflation and employment data this week, as well as the presidential debate between Kamala Harris and Donald Trump.
Consumer inflation declined to 2.5% in the United States in August, a three-year low, but there was an uptick in core inflation. On Thursday morning, the U.S. Department of Labor also reported that initial jobless claims had increased for the week ending Sept. 7.
The U.S. Federal Reserve is widely expected to cut its benchmark rate — which has been held at 5.25%-5.5% since July 2023 — at its meeting next week.”
Here is the full article: https://mexiconewsdaily.com/business/peso-rebounds-weakened-us-dollar/
Geoffrey Drayton said exactly what I was thinking the past few days
The best explanation I’ve ever seen.
Said in layman terms. TY
Forget what was printed because that is what the Bank of Mexico and the president economic advisors want everyone to know. Not going to happen that way. The “peso:” is weak in value and will continue to “slide” in value after Oct.1 and after the US elections. It’s a “moving target” the resy of the year, slowing going “down in value. and prolonging the “agony of defeat”.
OPTIMA has it about right : the pause – potential cancellation of investment and near shoring on the back of a badly designed judicial “reform” (read ; revenge on the judiciary for blocking AMLO a number of times) is likely going to weigh on valuation along with the usual suspects ; corruption, violence and now protected state enterprises
Difficult to see how a golden opportunity after 40 years of sub par growth could be recklessly squandered
Well said. When I arrived here 40 years ago somebody told me: “Never expect too much as you’ll only be disappointed.” I didn’t want to believe him but now I know what he meant.Mexico will always be like a Ferrari with an empty gas tank. In other words, great potential but always with an unhappy knack of grabbing defeat from the jaws of victory. Unless CSP charts a totally different course from AMLO things will only get worse over time.
Thank you for an explanation that is understandable. Excellent article.
Mexico’s interest rate of 10.75% more than compensates for higher inflation. Mexican economic fundamentals are far better than US. Better demographics, strong foreign investment and low debt. I predict peso/usd at 16.5 in one year.
Although I agree most of your comment, I don’t agree with your 16.5 prediction. I hope it goes to 20 and stays between 19 and 21. If I was a foreign company paying in pesos, I would like it to be close to 20.
I think that the the judicial reform were terrific and long overdue..
The Mexican ruling class has kept the population down for centuries.
Plus, many of the judges were so corrupt.
Viva Mexico
Mexico lindo & querido
Mr. Market doesn’t care what people want or hope. There is more natural money flows into peso than USD. Remittances, exports and foreign investment are all flows into peso.
“I predict peso/usd at 16.5 in one year.”
You actually predicted something on that order or similar would happen “quickly” just three weeks ago:
[email protected] August 24, 2024 At 6:53 am MXN peso at 19+ is a bargain. Will be back to sub 17 quickly.
When this was written, the peso was at 19.11 to 1. It hasn’t gone below 19.11 since. Not once.
I too want to thank you for the article, Travis. Very informative.
Nice article, thanks. Would also add to the list of variables; the rate of increase or decrease of foreign investment and nearshoring investments, Global concern over US Gov’t Debt levels and deficits (interest on debt passed defense spending for first time). I’m sure there are others.
One factor not taken into account here is the impact of the yen carry trade. Over the past years many investors sold short the yen and bought pesos, picking up a 10% interest differential. That was one reason for the peso’s puzzling strength the last two years. The reversal of that trade has caused the yen to be bought back and the peso sold. I agree that 19-20
feels like the most likely outcome for the near future.
Yes. The whole Super Peso nonsense was well-fueled by carry trades.
Up and down and all around! Nobody knows what will happen next! There is always a surprise around the corner! Don’t worry about it! 😉
Good article. And lots of good and astute comments. This post may be a little long winded but as an international bond trader for 30 years, we were constantly involved in currency trades. You are correct that normally the currency spreads (pricing between currency rates) are a function of the government interest rates between the two trading countries.What started this situation was a bond arbitrage, or “interest carry”, which was created by the Mexican government issuing 11.5% bonds. Hedge funds in the US were borrowing funds from Japan at a zero interest rate. They then converting yen to dollars, that they then leveraged, and bought the Mexican bonds, which meant they converted dollars to pesos. This drove the peso to 16-1. They then were making 11.5% on free money. But the trade is enhanced because they were trading in sovereign bonds which served as collateral, so you could leverage from 50-90%. Example: Buy $1 million in bonds, put up $100k, finance the rest. You are now making $115k in bond interest with only $100k invested plus interest which in this case is zero.
The only issue in this is how much can you buy? What happened. As is explained, non economic effects happened. People started selling pesos and Japan started to charge interest. Currency started moving towards 20 and cost of money was going up. The currency lost 25% on the 11.5% trade. We had a flash crash a few weeks ago as these trades were being unwound. Hence the quick move to $19-20 as bond/pesos were being sold.
These unsustainable interest rates of 11.5% were not a function of inflation, as we know it. The only inflation in Mexico is created by the government. As we know, Pemex and CFE are totally owned and controlled by the government. In the past most all of government funds came from these sources. Due to increasing expenses and a lack of re-investment in Pemex and CFE, the government needed more funds. The easiest way to do that is increase the price of fuel and energy. Unfortunately this affects every aspect of the economy. Hence, this manufactured inflation. Politically it is alway more expedient to blame something else for your failures. The economy at large is blamed and high interest rates are the cure. Nope!
As we know, presidents are elected for one six year term. But the party in power wants to stay in power. So Morena needs funds to make that happen. The current government can’t directly fund this, so wealthy investors are charged with helping raise the funds. This group is rewarded by buying government bonds that pay outrageous rates. This has nothing to do with the currency, but in a way it does. These high rates created the arbitrage.
A new president is elected in June and there is no need to continue with these high rates. Rates come down. Sheinbaum takes control Oct 1st. She understands that 16-1 on the peso discourages foreign investment. Many of these pending proposals were at 20-1. At 16-1 it costs 20% more to do business in Mexico. As you know, many of these projects are on hold. So Mexico needs to get it to 20-1 and keep it there.
Forward looking, as new businesses come to Mexico, there will pressure on the peso. The government needs to be actively involved to keep the peso stable.
Thanks for your time.
jbarrilesj – excellent comments. thank you for sharing.
Bravo! Bien hecho!
Yes, this is a solid article and an insightful comment by [email protected] stating the “self-manufactured inflation” effects of the PEMEX/CFE price increases and hinting on the limited independence of the Mexican Central Bank.
The Mexican Central Bank – celebrating this year 30 years of autonomy – is a well-respected institution and – to a great degree – perceived as independent. But it might be limited by its main objective “to maintain a low and stable inflation”. It might be time to change to a “dual mandate” to foment maximum employment and stable prices.
MND, Travis & [email protected]
THANK YOU !
I have lived in Mexico only five years. This is my first time rethinking about currency exchange and I have been woefully unable to do more than make under educated guesses at the changes as they occurred or read about it in the analysis of others.
Both of you have greatly enhanced my tepid understanding. Muchas Gracias, mi maestros!
Fabulous jbarrilesj!
All note the UBER importance of the government’s roll. My take has always been that the government can eff things up a whole lot easier than they can fix em.
The “peso” is headed for a deep hole especially after the elections if Trump wins, which right now, it looks like Mr. Trump is going to be re-elected. Big economic changes are in the future for Mexico when it comes to exporting “electric cars” and other Chinese’s products being manufactured in Mexico with China “backing”. A Hugh tax tariff is going to be implemented, so Mexico better get “ready” for the “big announcement, because “it is coming and it’s going to affect the “peso” even more. Kick China out of Mexico if you want to be a friend of the US and you care about Mexico’s future. Mexico is barking up the wrong tree with China. “Wake-Up Claudia and see “reality” for the sake of all people of Mexico and especially the “poor” worker who has to compete with “cheap Chinese’s Products. Mexico is not going to “win” this fight, especially the “poor and the extreme “poor”. “Open your “eyes” Claudia!!!!!
In the end, it only takes one Black Swan event to change matters. I our volatile world, it is probable. BBVA CDs are paying 10%, good for the short-term! Long-term? “Live not like there’s NO tomorrow, but IN CASE there’s no tomorrow” Viva Mexico!
One critical flaw, Travis. The US inflation and jobs data is completely made up, from scratch, for political purposes. For example, the most recent CPI calculation states that Healthcare costs are down 30% over the past five years. Who believes that?