Mexican Peso falls amid hawkish Fed, and rate cut expectation roil currency

Most recent article: Mexican Peso bottoms out as Obrador says Peso is backed by “strong economy”

• Mexican Peso weakened by political uncertainty following June 2 elections and upcoming judicial reforms by President AMLO.
• Political turmoil and judicial reform concerns in Mexico lead to over 10% depreciation since June 2 election.
• Fed Chair Powell expresses caution about inflation, signaling readiness to adjust policy if economic conditions change.
• USD/MXN trades at 18.76, gaining over 1% after Fed holds rates steady and revises down rate cut expectations.

The Mexican Peso remained on the defensive, extending its losses for the second straight day against the US Dollar after the Federal Reserve (Fed) decided to keep rates unchanged and downward revised interest rate cuts from three to just one. At the time of writing, the USD/MXN trades at 18.76, gaining more than 1%.

On Wednesday, the Fed maintained rates unchanged. They expressed that they’re not expecting that reducing rates would be appropriate, as they remained unconfident that inflation is moving sustainably toward 2%. They added that the Committee would be prepared to adjust the monetary policy stance as appropriate.

The Summary of Economic Projections (SEP) revealed that policymakers backpedaled. They were expecting three rate cuts, but most estimate just one toward the end of the year. Meanwhile, the economy is expected to grow above 2%, while the headline Personal Consumption Expenditure (PCE) Price Index and core PCE were upward revised.

Aside from this, Fed Chair Jerome Powell stated that they remain less confident about inflation than previously “in order to cut.” He added, "if jobs are to weaken unexpectedly, the Fed is ready to respond.” When asked about today’s US inflation report, he said that it’s just one report and that they need to see the deflation process evolve toward the Fed’s goal.

Mexico’s political turmoil has weakened the Mexican currency by more than 10% following the June 2 general election. Investors are nervous about President Andres Manuel Lopez Obrador’s (AMLO) imminent judicial reform in September, which would allow the popular election of judges and magistrates of the Supreme Court.

The dissolution of key autonomous bodies, including the INAI and the Electoral Institute (INE), poses a significant threat to Mexico's hard-won democracy, which has been in place since the 1990s. If implemented, this move could potentially disrupt the democratic processes that have been the cornerstone of Mexico's political and economic stability.

During his morning press conference, President AMLO belittled the markets. According to Reuters, he said, "They are wrong, respectfully, if they are thinking that we are going to go back on reforming the judiciary, which is rotten, which is dominated by corruption, just because there is financial nervousness."

The USD/MXN hit a new multi-month high of 18.99 during the European session amid political and economic uncertainty surrounding Mexico.

AMLO’s pending reforms will be submitted to the newly elected Mexican Congress once it takes office in September, one month before President-elect Claudia Sheinbaum begins her six-year presidency.

Across the border, May’s US inflation was softer than expected, which weakened the Greenback against a basket of six currencies, but not against the Peso.

Daily digest market movers: Mexican Peso on the defensive amidst political uncertainty

• In February 2024, AMLO put forward several proposals to the Mexican Congress. These include a Supreme Court reform that suggests electing Supreme Court ministers through popular vote; an electoral reform aimed at electing electoral commission councilors by popular vote and reducing multi-member representation; and a reform of autonomous bodies that proposes dissolving the transparency body.
• Mexican Peso depreciation could weigh on the Bank of Mexico's (Banxico) decision to ease policy, even though last month’s core inflation slowed. Therefore, keeping interest rates higher could prompt deceleration in the economy and increase odds of a recession.
• Morgan Stanley noted that if Mexico’s upcoming government and Congress adopted an unorthodox agenda, it would undermine Mexican institutions and be bearish for the Mexican Peso, which could weaken to 19.20.
• The US Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) remained unchanged at 0% MoM, falling short of the 0.1% monthly estimate and April's 0.3% increase. Over the twelve months leading to May, the CPI rose by 3.3%, below both April's figure and the 3.4% consensus.
• Core inflation figures decreased from 0.3% to 0.2% MoM. Annually, core inflation was 3.4%, which was lower than the expected 3.5% and April's 3.6%.
• The latest US inflation report increased the odds for a Fed rate cut in September, according to the CME FedWatch Tool, from 46.7% to 61.3%.
• December’s 2024 fed funds futures contract hints that investors expect 28 basis points of rate cuts by the Fed through the end of the year.

Technical analysis: Mexican Peso slides as USD/MXN approaches 19.00

The USD/MXN is bullishly biased even though the Peso has recovered some ground ahead of the Fed’s monetary policy decision. Once the exotic pair broke the four-year downslope resistance trendline, that opened the door for further upside. Momentum depicts that buyers are in charge, as portrayed by the Relative Strength Index (RSI) being overbought, hinting that bulls are taking a respite ahead of the Fed.

The USD/MXN's next resistance would be the year-to-date high of 18.99, followed by the March 20, 2023, high of 19.23. A breach of the latter will sponsor an uptick to 19.50, ahead of the psychological 20.00 mark.

On the other hand, sellers must push the USD/MXN back below the April 19 high of 18.15 if they want to keep the pair within the 18.00-18.15 trading range.