Mexico: Peso sinks amid coronavirus fears and oil price plunge; Banxico in spotlight
The Mexican peso plummeted against the U.S. dollar in the first half of March amid the collapse of international oil prices and market fears over the ongoing spread of coronavirus globally. The peso hit a new all-time low above 22.00 MXN per USD in intra-day trading on 9 March, prompting Mexico’s Central Bank (Banxico) to intervene in the FX market to prop up the currency that same day. The peso continued to reel through the second week of the month and ended 13 March at 21.93 per USD, marking a 15.2% depreciation over the same day in February. Moreover, the currency was down 12.1% year-on-year and 13.7% year-to-date.
The peso came under significant pressure through mid-March on the back of mounting concerns over the fast-spreading coronavirus and its impact on global economic activity, which sent emerging-market assets tumbling worldwide as investors flocked to safe-haven assets. On top of that, global oil prices crashed and hit their lowest levels since 1991 on 9 March after OPEC+ talks to cut production broke down, sparking a price war between Russia and Saudi Arabia and thus creating a supply shock in global energy markets. Given the peso is closely tied to oil market developments and is the most liquid currency in Latin America, it was battered by both of these extraordinary external events. As a result, on 9 March Banxico ramped up the size of its currency hedging program from USD 20 billion to USD 30 billion to maintain the orderly functioning of the FX market. Exacerbating matters, the crash in oil prices also spells bad news for the already-fragile finances of state-owned Pemex, as it raises the specter of further credit rating downgrades which in turn could hurt the rating standing of the sovereign.
Meanwhile, the plunge in the currency has placed Banxico in a tough position, which will need to balance out various forces when making its policy decision at the upcoming 26 March meeting. On the one hand, the economy contracted for the first time in a decade in 2019 and available data hints that activity is likely to remain somewhat depressed going forward. Moreover, the U.S. Federal Reserve delivered an emergency rate cut on 3 March and another one to near zero on 15 March, providing Banxico the space to loosen its stance. On the other hand, inflation accelerated to a seven-month high of 3.7% in February (January: 3.2%), coming in higher-than-expected and drifting further above Banxico’s 3.0% target, while core inflation remained sticky at 3.7%. The sharp depreciation of the peso only heightens risks to the inflation outlook while also demonstrating the vulnerability of Mexican assets to risk-off sentiment and sudden capital outflows, which is likely to be an issue of concern for the Bank and thus potentially shrinking its space for maneuver.
As it currently stands, the peso is expected to recover some of its losses by year-end, but flagging economic activity, uncertainty over the full economic impact of the coronavirus pandemic, and volatile investor sentiment are set to weigh on its trajectory. As for the direction of monetary policy ahead, it is broadly expected that Banxico will lower its benchmark rate at the March meeting, though uncertainty remains over the magnitude of the cut.