Buenos Noches readers. This article's purpose is to convince you why the Mexican
peso (“MXN”) is going to rise against the almighty U.S. dollar.
Introduction:
As a background, we all know who won the U.S. Election. The victory of Donald Trump was a seismic
event in history.
- Stocks are rising
- Commodities and precious metals are stumbling
- Bonds are falling
- The smell of inflation is back in the air
- And the U.S. dollar is within arms-reach of parity with the Euro
Together these changes in Capital Markets are called the
“Trump Trade.” One victim not just in
the markets but in geopolitics, has been Mexico. Mexico has been the “poster child” for
everything that has gone wrong with the United States. According to Trump, the NAFTA trade agreement
has taken jobs away from hardworking Americans, resulting in a lower standard
of living. Did you know that 9 out of 10
cars produced in Mexico get shipped to the U.S. (data sourced from UBS)? And
then there’s the issue of immigration. Trump
wants to keep Mexicans out. How’s he
gonna do that? Well I think we are know
that answer!
Despite haven’t become President yet, there has been a real
fallout on the Mexican economy and the MXN currency. With every tweet, the Peso keeps
declining. It is now conventional wisdom
that the MXN will continue to weaken over the next year.
I don’t believe that to be the case. While there’s the Trump Trade, and that’s
powerful. There’s also something called
the “Madness of Crowds.” This is when
every one of us agrees on something whether or not it’s based on logic. There have been examples of Manias in the
past, of which some were based on faulty-logic.
They include:
·
Tulip mania (1637)
·
Roaring Twenties (1922-1929)
·
Dot-Com Bubble (1995-2000)
·
Real-Estate bubbles (2006-2009)
·
Bitcoin (present day)
Bubbles usually end badly. The Trump Rally too, will bust. If this
happens, it will be the end for the almighty dollar. I would like to give you five reasons why the
Mexican peso will reverse course and RISE against the U.S. dollar.
1.
First, is something called “selling on the
news.” This is a reversal of a market
price which goes in complete opposite of what was expected. One often sees this when a company’s share
price declines after reporting excellent earnings. This is due to the news already being factored
into the share price. Once Trump becomes
President, I expect the Peso to reverse its downtrend if rise in earnest by
First Half 2017 (think Cinco de Mayo).
2.
The U.S. economy won’t move from 2% GDP growth
to 4% just because there’s a different guy in the White House. Running the U.S.
government is not the same as running the Trump business empire. You don’t just give marching orders and have
your plan executed. There’s a whole
process to the process, with pushback from Congress, lobbyists, etc. In fact, according to a WSJ
survey of economists, 2018 GDP was upwardly revised by just one-quarter of
a percent (to 2.4%).
3.
Differences in real interest rates affect
currencies. The currency with the higher
interest rates attracts more investments of which causes an increase in demand
for investments denominated in that higher yielding currency. Mexico’s
funding rate, for example is nearly double that of U.S 30YR rates. It is true that a proportion of the higher
rate is attributed to inflation, though the Bank of Mexico has aggressively
raised rates (in each of its last three meetings) to nip it in the bud. One can determine whether or not the
difference in interest rates is affecting the currency by looking at forward
currency rates. Presently forward currency
rates are slightly higher than present rates indicating traders expect to
decline slowly.
4.
Oil prices are rising: After plunging in 2015, oil prices rose 45%
in 2016. Oil prices are expected to
remain elevated due to the Nov’16 OPEC
agreement. Mexico’s budget is highly
dependent on taxes it receives from PEMEX, the national oil company. PEMEX
provides nearly 20%
of Mexico’s budget and 5% of exports (mostly to the U.S.). Oil is priced in
USD so the net effect could be substantial.
5.
Purchasing Power Parity: This is an economic theory that determines
what the exchange rate should be based on a basket of goods of one country
divided by a basket of goods from another country. The Economist magazine popularized using the
price of a Big Mac
in one country over that of another country to determine the exchange rate. Its index shows that the Mexican Peso is over
50% undervalued compared to the USD (and its data was before the U.S.
election).
Factors working against a stronger Peso are the continuing Drug War
in Mexico and risk to the Current Account surplus with the U.S. According to the New
York Times, in the first 10 months of 2016, there were 17,063 homicide
cases in Mexico, already more than 2015’s total and the highest 10-month tally
since 2012. The Drug War has become an
almost civil war on the country resulting not only in lost innocent lives but
in lower potential economic growth.
Mexican’s trade surplus
or Current Account could also hamper a strengthening Peso if Trump initiates
trade tariffs onto Mexican imports. Exports
are typically good for the local peso as U.S. importers would have to convert
their dollars in order to pay for the Mexican exports, hence more demand for
pesos. However, I believe import tariffs
are doubtful as this could lead to a trade war with Mexico.
Conclusion:
The currency market is complex and not every factor I have
stated to you will affect the Peso. In
summary, I believe the peso will rise due to changing investor expectations,
slower U.S. economic growth compared to Mexico, higher interest rates in Mexico,
a stronger economy in Mexico due to greater oil exports, and due to Purchasing
Power Parity which shows that Big Macs cost just 50% of what they cost here in
the U.S. The peso will reverse its
downtrend by 1H’17 – think Cinco de Mayo!
