Dollar on the Rise: Mexican Peso Devalues as 'Carry Trade' Ends

The U.S. dollar is seeing increased searches after the Mexican peso registered the worst performance among major global currencies last month, with a drop of almost 6%. This sharp depreciation is driven by the reduction in the interest rate differential between the United States and Mexico, which has diminished the attractiveness of the "carry trade" strategy.

The depreciation of the Mexican peso

The Mexican currency, previously known as the "super peso," fell by almost 6% this month, marking the worst performance among all currencies tracked by Bloomberg. This decline occurred after the peso reached a two-year high in early September. Analysts from institutions such as Société Générale, Morgan Stanley, and Banco Base are revising down their projections for the Mexican peso by the end of the year.

The end of the "carry trade party"

The main reason for the peso's depreciation is linked to the loss of attractiveness of the "carry trade." This strategy involves borrowing in currencies with low interest rates to invest in others that offer higher returns. According to Gabriela Siller, director of economic analysis at Banco Base, "the carry trade party is over." The differential between U.S. and Mexican interest rates has fallen to its lowest level since at least 2008, having been halved in the last year, according to Bloomberg data.

Monetary policy decisions

The dynamic of the interest rate differential was directly impacted by monetary policy decisions. A hike in U.S. Federal Reserve rates, followed by the Bank of Mexico's (Banxico) decision to keep its rates unchanged on September 24, diminished the advantage that had sustained the popular "carry trade." Brendan McKenna, emerging markets strategist at Société Générale, explained that the peso was already a vulnerable currency. He added that, "once Banxico confirmed its willingness to decouple from the Fed and allow the rate differential to narrow, these vulnerabilities materialized, and the peso reacted accordingly."

New forecasts for the peso

Given this scenario, several financial institutions have adjusted their expectations. Société Générale revised its year-end forecast for the peso to 18 per dollar, aligned with current levels, a change from the previously projected 17.25. Morgan Stanley revised its fourth-quarter forecast to 18.25 per dollar, a 6% adjustment from its previous prognosis. Banco Base, in turn, changed its estimate for the same period to 18.20 per dollar, from 17.80. Deutsche Bank also predicts an exchange rate of 18.20 pesos per dollar at year-end, compared to 17.5 previously.

Additional pressure factors

In addition to the "carry trade" dynamic, the Mexican peso, one of the most liquid emerging market currencies, was also pressured by a generalized sell-off in risk assets. This occurred as U.S. bond yields reached their highest levels in decades. Carlos Muñoz-Cárcamo, strategist at Deutsche Bank, wrote that the peso "is losing attractiveness" for the carry trade, as it appears to be one of the most expensive currencies among its peers and positioning "seems excessive." Antonio Di Giacomo, senior market analyst at XS.com, reinforces that "as long as U.S. yields remain high and the market anticipates a more restrictive Fed, it will be difficult for the peso to sustainably recover lost ground."

With information from Yahoo Finanzas.