Mexico’s peso faced significant volatility recently, with a dramatic drop and subsequent recovery highlighting the risks associated with carry trade positions in Latin America. On Monday, the peso fell to its lowest level in nearly two years, leading the losses among regional currencies.
The peso initially dropped by as much as 5.4%, a movement larger than its annual change in six of the last seven years. This sharp decline saw the currency briefly fall below 20 pesos per dollar for the first time since October 2022. Although it rebounded to trade relatively unchanged, the peso still experienced a slight dip later in the day.
This recent decline made the Mexican peso the largest decliner among emerging markets over the past month, with a 6.6% drop driven by multiple global economic challenges. A surprise increase in U.S. unemployment reported on Friday raised concerns about a potential hard landing in the U.S. economy, on which Mexico heavily relies for trade. Additionally, a rally in the yen, a popular funding currency for carry trades, triggered the rapid unwinding of long positions in the Mexican currency.
Francisco Campos, an economist at Deutsche Bank, explained, “The impact on the Mexican peso has been disproportionately large. It’s a double-whammy effect in a context where it was already facing idiosyncratic challenges.”
Investors began unwinding carry trades—borrowing in low-yielding currencies to invest in higher-yielding ones—as Japanese authorities intervened to strengthen the yen. This surprise move, combined with the Bank of Japan’s unexpected interest rate hike, the first since 2007, exacerbated the peso’s volatility.
The peso’s rally of up to 3.4% on Monday reflected concerns over a potential U.S. recession, but domestic factors also played a role. “I worry about Mexican politics coming back into play when the new parliament sits in September — and that might prevent the peso from straying too far below 19.00 now,” noted Chris Turner, head of foreign-exchange strategy at ING.
Earlier this year, volatility spiked when the ruling party gained a near supermajority in Congress, raising fears of radical policy changes. A significant concern is whether incoming President Claudia Sheinbaum will attempt to reform the constitution. These political uncertainties followed a period of strength for the peso, which appreciated by 5% in 2022 and 13% last year, reaching a nine-year high in April.
President Andres Manuel Lopez Obrador, proud of the peso’s performance during his tenure, assured that Mexico’s record-high international reserves would help mitigate the currency’s depreciation.
While the peso faces limited positive drivers in the near term, the potential for further significant losses may be constrained. Brad Bechtel, global head of foreign exchange at Jefferies in New York, commented, “It’s always hard to tell in these big unwindings, but I would think we are closer to the finish line.”
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