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”

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.