Mex­ico tries to keep peso spec­u­la­tors off bal­ance

▶ A rate hike and se­cret dol­lar sales could de­ter spec­u­la­tors ▶ “There’s a risk the cen­tral bank will be on the other side of your trade”

Bloomberg Businessweek (North America) - - Contents - �Is­abella Cota and Nacha Cat­tan

Mex­ico is tired of see­ing the peso picked on. It’s de­pre­ci­ated as much as 13 per­cent against the dol­lar this year in in­tra­day trad­ing, mak­ing it the worstper­form­ing ma­jor cur­rency of 2016.

Weak eco­nomic fun­da­men­tals aren’t what’s sap­ping the peso’s strength. In­fla­tion in Mex­ico is near a 47-year low, and an­nual growth is ex­pected to ac­cel­er­ate for a third con­sec­u­tive year, to 2.6 per­cent. The peso is vul­ner­a­ble be­cause it’s the most-traded cur­rency in emerg­ing mar­kets, which makes it an ideal hedg­ing in­stru­ment for spec­u­la­tors who are bet­ting on the di­rec­tion of other de­vel­op­ing economies.

The peso’s daily trad­ing vol­ume of $135 bil­lion a day is $15 bil­lion higher than that for China’s yuan, the nextmost-traded among de­vel­op­ing coun­tries, ac­cord­ing to data from the Bank for In­ter­na­tional Set­tle­ments. The peso also trades on global mar­kets 24 hours a day, five days a week. That’s true of only two other emerg­ing-mar­ket cur­ren­cies—the South African rand and the Turk­ish lira, both of which have far lower daily trad­ing vol­umes. So if there’s bad news out of Brasilia on a Fri­day evening, af­ter the mar­kets there are closed for busi­ness, it’s the peso in­stead of the real that takes a beat­ing. “The peso was be­ing used to hedge not only Mex­ico risk but ev­ery­thing else,” says Ed­uardo Suarez, a Latin Amer­ica strate­gist at Bank of Nova Sco­tia.

Just days af­ter the peso flirted with an all-time low of 20 to the dol­lar in Fe­bru­ary, of­fi­cials swung into ac­tion. On Feb. 17, in a rare joint an­nounce­ment, the cen­tral bank gov­er­nor and fi­nance min­is­ter said Mex­ico would scrap its sys­tem of pre­dictable dol­lar auc­tions and start sell­ing green­backs di­rectly to banks, at any time and in undis­closed amounts. (Dol­lar sales bol­ster the peso by re­mov­ing some of the lo­cal cur­rency from cir­cu­la­tion.) “We are try­ing to an­chor the value of the cur­rency” to eco­nomic fun­da­men­tals, Min­is­ter of Fi­nance Luis Vide­garay said in an in­ter­view two days later.

That’s a po­lite way of telling spec­u­la­tors to back off. “What the govern­ment is say­ing is ba­si­cally, ‘Hey, if you’re go­ing to choose a cur­rency as a proxy for emerg­ing-mar­ket risk, lemme just tell you, there’s a risk the cen­tral bank will be on the other side of your trade,’ ” says Ben­ito Ber­ber, se­nior econ­o­mist for Latin Amer­ica at No­mura Hold­ings in New York.

To drive home the point, Bank of Mex­ico Gov­er­nor Agustín Carstens jolted the mar­kets by rais­ing the bench­mark in­ter­est rate by a half­per­cent, to 3.75 per­cent, on Feb. 17— the first time the bank has raised rates out­side of a sched­uled meet­ing in at least 13 years. A higher in­ter­est rate makes it more ex­pen­sive for spec­u­la­tors to bor­row pe­sos to buy other as­sets. The vol­ume of such trades has ex­ploded thanks to high-speed com­put­er­ized trad­ing, which is a rea­son the peso has been at the mercy of events far be­yond Mex­ico’s bor­ders. “Mex­ico has drawn a line in the sand with high-fre­quency firms,” says Ale­jan­dro Silva, a part­ner at Silva Cap­i­tal Man­age­ment in Chicago. “If you are a high-fre­quency firm, you have to con­stantly be won­der­ing if some­one is go­ing to come in and in­ter­vene in the cur­rency.”

The peso has gained as much as 5 per­cent since the moves. If in­vestors thought Mex­ico’s econ­omy in se­ri­ous trou­ble, ma­neu­vers of this type would have done lit­tle to slow the peso’s slide.

Not all of the peso’s weak­ness can be blamed on ex­ter­nal fac­tors, how­ever. The price of oil, which pro­vides one­fifth of pub­lic rev­enue, has tum­bled, and the state-run oil gi­ant Petróleos Mex­i­canos posted a record loss in 2015, the 11th con­sec­u­tive year in which it logged a drop in crude out­put.

Ab­sent any signs of deeper trou­ble in the econ­omy, the cen­tral bank’s rate hike and the new method for dol­lar sales should con­tinue to buoy the cur­rency. What they did was “very in­tel­li­gent,” says Nova Sco­tia’s Suarez. “What is go­ing to change is that the peso will no longer be the most bul­lied kid in the class.” The bot­tom line Mex­i­can pol­i­cy­mak­ers have un­veiled mea­sures to dis­cour­age spec­u­la­tors from us­ing the peso as a hedg­ing in­stru­ment.

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