EconomyWhat happens to the Mexican peso with Fed rates

What happens to the Mexican peso with Fed rates

The market always tries to get ahead in order to get the most out of it, the bet now is on how much the United States Federal Reserve will increase its rate. At the moment, a probability of more than 60% is discounted that the increase will be 75 basis points.

If confirmed, in its statement on Wednesday, July 27 at 1:00 p.m., it will be the second consecutive rise in this level, an increase not seen in 30 years and that has been forced due to the fact that inflation in the United States rose, in June, 9.1%, its largest increase since November 1981.

The increase in the rate is one of the tools used by central banks to curb inflation, as money becomes more expensive.

After knowing the inflation data, at the beginning of July, the market considered the possibility that the Fed hike would be 100 base points, which took the exchange rate to minimum levels of the year of up to 21.08 units.

However, several officials from the Federal Open Market Committee (FOMC) indicated, a few days ago, that they would be supporting only a rise of 75 basis points, and the exchange rate began to adjust levels of 20.40 pesos per dollar.

According to data from the Bank of Mexico (Banxico), the Mexican currency closed this Monday with a price of 20.4478 units per dollar, which meant an appreciation of 0.60% compared to its close on Friday.

Alejandro Saldaña, chief economist at Grupo Financiero BX+, said that the Mexican peso has managed to maintain its price against the dollar so far this year, at least until now. However, he stressed that the exchange parity has not been exempt from volatility, largely due to global factors, such as the war in Ukraine, inflation and the rise in interest rates, which in turn, in recent weeks, has sparked fears of a global recession.

What happens if the 75 basis points are achieved?

If the 75 base point scenario is met, the reaction of the Mexican peso will be very limited, positive but marginal, since the market has already incorporated that scenario into its estimates, says James Salazar, deputy director of economic analysis at CI Banco.

“It is true that the movement is expected to be 75 basis points, but that would not imply a specific movement, since the markets have anticipated that movement,” said Jessica Roldan, chief economist at Finamex.

Even if there is no surprise, traders will be watching the statement and the conference (to be held on July 27 at 1:30 p.m.) from Fed Chairman Jerome Powell himself, as he will outline his expectations for economic activity and at the same time inflation, explained Roldán.

Still, anything can happen. In the wake of the latest inflation figure which far exceeded all forecasts, all bets were raised that it could be a 100 basis point hike and the 50 basis point option was pretty much ruled out. But what if the US central bank surprises the markets?

How would the peso react to an increase of 100 basis points?

In one of the scenarios to be considered is the surprising increase of 100 base points on the interest rate. Analysts mentioned that this would give strength to the dollar in the face of the uncertainty of how far the Fed can go without affecting the pace of the economy.

“Weeks ago, when the inflation data for the month of June was known, it was when the possibility that this increase was 100 basis points was discounted. At that time the peso reached 21.08 units per dollar and we could certainly reach that level again (even 21.20 units), we would have a really strong reaction, since this would be a sign that the Fed is very concerned about inflation and in any case, it would be concentrating on this goal beyond the situation that may arise with a recession,” said Janneth Quiroz, deputy director of economic analysis at Monex.

Salazar from CI Banco agrees and expects that, in case of surprise at 100 basis points, the reaction of the currency could be much stronger downwards and have a depreciation of 20 to 25 cents during Wednesday.

“Right now the outlook is still somewhat uncertain and the risks to inflation are skewed to the upside, so even if not this time, going forward we can’t rule out that the Fed may have to implement more aggressive monetary tightening in the future. what we expect today, which would most likely end up generating pressure on the price of the Mexican peso and other currencies against the dollar,” added Salazar.

The debate centers on those who expect a 75 basis point hike arguing that the Fed will opt for a more hawkish tone ( referring to a restrictive monetary policy) and that a higher hike may not be necessary because that will intensify the risk of recession, since although the increase in the rate can curb inflation, it also negatively affects economic growth.

On the other hand, those who believe he should raise the rate by 100 points are clear that if he does not do so, the Fed chairman will fall short in his fight to contain inflation.

If it was just a 50 basis point hike?

If the increase of the Federal Reserve were less aggressive than expected, the Mexican peso could take advantage of the situation and be below 20 units per dollar, because the difference between the rates of both countries will be 625 points. base.

“Under this scenario, it would take the exchange rate to minimum levels of 19.80 pesos per dollar, since in Mexico it is considered that the central bank will make an increase of 75 basis points on August 11, which gives it a differential in rates. of 625 base points and would make the local currency more attractive by paying more yield”, commented Quiroz.

Eduardo Ramos, financial markets analyst at ATFX Latin America, said it is an interesting movement and that a strengthened peso could be seen, since inflation levels in Mexico remain on the rise and the labor market had stable results. He added that under this scenario, the currency could specify a floor of 19.70 to 19.80 units with the assumption that Banxico can increase its interest rate by 75 basis points.

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