The fix
rate surpassed $14 on December 2 for the first time in thirty months. On Monday,
December 8, the cost of a dollar had jumped to $14.40. That same day, the
Exchange Commission announced it is reviving the auction mechanism it devised
in October 2008 as a “preventative measure”. If the exchange rate moves more
than 1.5% in the course of a single trading day, Banco de México (Banxico)
will sell up to US$200 million dollars into the exchange markets. Today, the 9th,
the fix rate retreated three centavos, the first drop in the cost of a dollar
since mid-November.
A couple of
hundred million dollars isn’t enough money to stop a run on the peso. In the
past, though, it’s proven to be enough to prevent a panic from spreading. When
trading volumes are low, a few transactions can send the exchange rate soaring.
The idea behind the auctioning of options to buy dollars is simple: since a large,
abrupt jump in the cost of a dollar can cause investors to sell pesos first and
ask questions later, make some more dollars available to give investors time to
see if the problem is more than one of thin markets.
The
fundamental question is why the peso has been steadily weakening since May. The
strength of the dollar is an explanation that highlights the fact that
developments outside of Mexico are behind the weakening of the peso and that
the peso isn’t alone: the currencies of other emerging markets have weakened
along with the Euro. That’s not the only story, though.
Portfolio
investment flows are another face of the same coin. Those depend on the
attractiveness of peso-denominated investments compared to investments in other
currencies and the fluctuations in investors’ appetite for risk and search for
returns. The magnitude of
portfolio investment flows can swing wildly from quarter to quarter. This year
provides a good example. In the first nine months of 2014, portfolio investment
totaled US$19.9 billion. Of that, US$4.9 billion entered in Q1 and US$13.4
billion, in Q2. Inflows in Q3 plunged to US$1.7 billion, their lowest level
since the financial crisis with the exception of the “taper tantrum” in Q2 2013
sparked by the announcement that, at some point, the Fed would begin to dial
down asset purchases.
Will the
peso strengthen or will it continue to depreciate? In 2011 and 2012 – not so
very long ago – we saw steeper jumps in the cost of a dollar, ones followed by
a recovery of the peso. In July 2011, the cost of a dollar averaged $11.67.
Five months later, a dollar cost, on average, $13.76. Two months after that, in
February 2012, the cost of a dollar averaged $12.78, only to bounce back to
$13.92 in September. Over the course of fourteen months, the fix exchange rate
traded in a $2.25 range (monthly averages), ending the period $1.27 higher than
it began. By those standards, the peso’s variations over the last fourteen
months have been relatively mild. In October 2013, the fix rate averaged
$13.26. Assuming, for a moment, that the rates we’ve seen in the first six trading days of December hold for the rest of the
month, the range will be less than a peso.
Don’t
expect the peso to appreciate much before Christmas: between holiday travel
plans and normal quarter and year-end business transactions, there’s typically
a seasonal increase in the demand for dollars. We don’t expect investors to
redeploy money to emerging markets towards the end of the year, as they often
do once they’ve locked in their annual bonuses.
The peso
could well appreciate at the very end of the year. Then again, it might not.
Relative returns, confidence, oil prices, and perceptions of the strength of
the world economy will all play a role in determining capital flows. But,
foreign investment flows don’t depend on just exogenous events. The reforms
approved during this Administration piqued interest in Mexico’s future. While
investors in money market obligations may focus most on how returns today
compare to returns in other countries, equity investors will be very interested
in how the reforms passed during this Administration are implemented.
