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#45 - Buy the dip in USDMXN

We go underweight MXN in our modelportfolio as valuation, technicals and flows turn bearish.

What a year for the MXN versus the USD! As of 16Aug23 the peso appreciated by about 12% (ytd) versus the USD, the second best in our FX universe and only trumped by the Colombian peso (+15%).

Why the strong outperformance?

Mexico benefits from several US administration acts and especially the CHIPS act, which includes more than USD50bn in incentives to build new facilities to reduce dependence from Asia. Mexico is expected to be a main beneficiary, from the manufacturing facilities for semiconductors to testing, packaging and assembly of chips. This should support FDIs, which are trending higher since 2000, for the years to come.

Chart 1: Mexico FDI in USD million

Mexico and the peso was also boosted by the outperformance of the US economy given the close relationship of the business cycle with the US, which is the dominant export market for Mexico. The trade balance has improved markedly, growth has surprised to the upside and the Central Bank has raised the policy rate to 11.25% to contain inflation.

Hence, strong growth, high carry and positive flows were all supportive of a stronger Mexican peso.

Chart 2: Mexico Trade Balance

Why do we go underweight MXN?

First, we do expect the outperformance of the US economy to run out in the next quarters. The cyclical growth tailwind is likely to wane leading to less support from improving trade flows. In Addition, although the CHIPS act will remain a long-term support, we do think this is already in the price.

Second, Valuation becomes very stretched in MXN. On our REER scorecard, MXN is the fifth most overvalued FX in our FX universe on our weighted total score and the second most overvalued on our 5 year score.

Chart 3: MXN looks expensive on REER basis

Third, long-term USDMXN chart shows a strong trendline support around the current levels 16.70/17.00. In combination with very oversold oscillators and the recent USD recovery, we do see the risk clearly biased for a move higher. We target 20.00 (medium-term) in such a recovery and put a stop at 16.50 (weekly close).

Chart 4: USDMXN testing the lower channel support amidst oversold oscillators

Fourth, MXN has appreciated in each month so far in 2023 (Jan-Jul). The only other year this happened was 2008, after which MXN depreciated by more than 30%. Seasonal factors are a drag into autumn as FDIs are slowing down into year-end and the trade balance usually deteriorates in Q3.

Chart 5: USDMXN Seasonility

Bottom Line: Buy the dip in USDMXN for a medium-term recovery towards 20.00 as technicals, valuation and flows suggest the strong rally is over.


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