Over the past month, the Mexican peso has depreciated nearly 4% and is one of the worst-performing Latin American currencies.
Several domestic factors have led to this performance. These include a deteriorating political outlook, a still lackluster response to the COVID-19 crisis and rising cases of civil unrest. These factors have all reflected in the poor performance of local assets amid repricing of U.S. monetary policy expectations.
Still, the factor that most likely contributed the most to the peso’s underperformance is inflation. Specifically this refers to signs, such as the February CPI data, that indicate inflation is starting to rise. This complicates the foreign exchange picture, as domestic economic activity remains sluggish, thus leaving markets hesitant to price out the possibility of further rate cuts.
At the same time, across the border to the north, President Biden is expected to sign the $1.9 trillion American Rescue Plan this Friday, which should be an economic positive for Mexico. In 2020, stimulus payments to U.S. workers resulted in a large spike in inflows into Mexico that totaled roughly 4% of GDP and helped to improve the country’s balance-of-payments picture. With another round of massive stimulus on the way coupled with improving U.S. growth, it is reasonable to expect a continuation of inflows into Mexico, especially with domestic economic conditions lagging those in the U.S.
However, it remains unclear what the impact on the peso exchange rate will be, as empirical evidence on this is far from clear. Back in 2020, peso performance lagged most of its peers despite fund inflows being quite strong. This is possibly due to a current account balance that is already in surplus, reducing the marginal support to the exchange rate that additional funds would otherwise have in a country that has a less favorable balance-of-payments picture.
So while fiscal stimulus in the U.S. is an economic positive for Mexico, the Mexican peso will still need a more confident growth outlook and increased clarity on Banxico’s monetary policy path as a prerequisite for the stimulus story to lead to sustained currency strength. | |
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