Mexican Peso recovers as carry-trade effect fades

• The Mexican Peso is strengthening as the effects of the unwinding carry trade diminish. 
• Gains may be capped by continued bets that Banxico will cut interest rates in August. 
• The Peso gains a backlift as Trump loses his lead in opinion polls. 

The Mexican Peso (MXN) recovers in its most traded pairs on Friday after an over-week-long sell-off. The Peso’s decline came on the back of a combination of an unwinding of the Peso-supportive “carry trade”, weaker Mexican macroeconomic data, and fears of the impact on trade with the US in the event of a former President Donald Trump’s victory at the US presidential elections in November.

At the time of writing, one US Dollar (USD) buys 18.31 Mexican Pesos, EUR/MXN trades at 19.88, and GBP/MXN at 23.57.

Mexican Peso recovers as carry trade effect dissipates

The Mexican Peso recovers on Friday as the factor that was pushing it lower – the unwinding of the carry trade – loses momentum. Carry trade involves investors borrowing in a currency with a low interest rate, such as the Japanese Yen (JPY), and investing in a currency with a higher interest rate, such as the Peso. However, with interest rates in Japan expected to rise after the release of higher Tokyo inflation data – and the Yen appreciating – the carry trade lost its luster. This led to the sudden unwinding of large positions built up in the Peso.  

Thursday saw the Japanese Yen reverse its course, however, and begin weakening again, making the carry trade attractive once more. This capped the decline witnessed in the Mexican Peso which has steadied and recouped losses as a result. 

Peso’s gains to be limited as Banxico expected to cut interest rates

However, the Mexican Peso’s gains are likely to be capped as investors continue expecting the Banco de México (Banxico) to lower interest rates, most probably in August. This will likely pressure the MXN since lower interest rates reduce foreign capital inflows. 

Mexican 1st Half Month inflation data for July was mixed, but investors focused on the core figure which came out more or less in line with expectations and showed inflation moderating. The higher-than-expected headline inflation result was put down to temporary factors. 

The divergence between core and headline inflation is something Banxico policymakers have been reiterating in their meetings, so it would have come as no surprise to investors. Despite the unexpected rise in headline inflation, it is unlikely to dissuade Banxico from cutting interest rates to stimulate moribund growth. 

Peso supported by Kamala Harris’ performance in polls 

Another factor weakening the Mexican Peso was the fear that former US President Donald Trump would win the US presidential election. Trump’s “America First” agenda and choice of known anti-China advocate J.D. Vance as his running mate were viewed as likely to impose restrictions on trade with Mexico that could hurt the Peso. 

The recent success of Democrat nominee and Vice-President Kamala Harris in opinion polls, however, suggests it will be a close race, and Trump is by no means assured a victory. The latest poll by the Saint Anselm College Survey Center, on Wednesday, for example, places Harris ahead with 50% of the vote and Trump trailing with 44%. This has taken some pressure off the Peso.

Technical Analysis: USD/MXN retests resistance at June 28 high

USD/MXN has retested the June 28 high at 18.60 and pulled back. It has formed a bearish Shooting Star Japanese candlestick pattern. If Friday ends as a bearish red candlestick it will add confirmatory evidence to the Shooting Star and suggest more downside in the very near-term.

USD/MXN Daily Chart 

Despite the bearish candlestick pattern, the trend appears to be bullish in the short term for USD/MXN, and given the “trend is your friend,” this still technically still favors bullish bets overall. 

Thus, there is a risk the pair could simply recover and continue higher. A decisive break above the June 28 swing high at 18.60 will reconfirm the uptrending bias and suggest a continuation up to the next target at 19.00 (June 12 high). 

A decisive break would be one accompanied by a long green candlestick that breaks cleanly above the resistance level and closes near its high or three green candlesticks that break above the level in a row. 

Meanwhile, the direction of the medium and long-term trends remain in doubt.