lunes, 29 de septiembre de 2014

Ouch: the peso returns to beginning of year highs...

The fix rate peso jumped to $13.49 today, matching its January 24 high for the year. The  monthly fix rate averaged $13.23 with just a day left in September, in line with its first quarter average. Just two months ago, in July, the fix rate averaged $12.98. What's going on?

The explanation undoubtedly lies in portfolio investment flows and the impact of a stronger dollar on the attractiveness of carry trade investments. The carry trade entails borrowing in a strong currency (like the dollar) and investing the proceeds of the loan in bonds in a weaker currency (like the peso) that pay a higher interest rate than that charged on the dollar loan. So long as the dollar doesn't strengthen (or, the flip side, the peso doesn't weaken), investors reap the yield differential. If the dollar weakens (or the peso strengthens), the currency losses can swamp the gains from the interest rate differential.

The size of the carry trade in emerging markets isn't really known. However, one estimate puts it at a very hefty US$2 trillion. The Bank for International Settlements indicates that foreign ownership of emerging markets' debt rose from 8% in 2007 to 17% in 2012.

Mexico was an early beneficiary of carry trade inflows. The relative size and depth of its bond markets mean that peso-denominated bonds remain an important destination for foreign investors. In Mexico, along with Poland, Hungary and Indonesia, foreign investors hold 35% or more of government bonds.

The strength of the dollar translates into weaker currencies around the world, including the peso. Today's Financial Times presents three reasons why the dollar will remain strong: the recovery of the US economy, the end of QE, and the ECB's adherence to a more dovish monetary policy. (See the complete article at

Unless peso interest rates rise or the peso strengthens, portfolio investment is not likely to flow into Mexico in the massive quantities we saw in 2011 and 2012.

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