New Currency Crisis Dawns: Mexican Peso Plunges to Record Low Against the Dollar

The flight into US dollars! Dollar-denominated debts of Mexican companies weigh heavily.

As the coronavirus crisis roils the global economy, the strengthening dollar is causing all manner of stress and mayhem for national economies and their respective currencies. Nowhere is this clearer than in Mexico, whose currency, the peso, never really recovered from the last crisis and is now collapsing all over again. As of 4 p.m. Monday (Mexican time), it had tumbled over 3% to a record low of 25.42 pesos to the U.S. dollar.

Even by historic standards, the sell-off has been relentless. In the past 16 days, the peso has experienced 16 record daily lows. Not since the height of the last peso crisis, five years ago, has the currency notched up so many new lows in one single month. During that crisis, which lasted from late 2014 to late 2016, the peso lost roughly a third of its value against the greenback, none of which it was able to claw back. During this new crisis, which has so far spanned no more than a month, the peso has lost 26% of its value. The chart shows the value of 1 peso, which has plunged from $0.054 on Feb. 22 to $0.039 today:

The Mexico peso is among a number of emerging market currencies that have become popular vehicles for carry trades, offering juicy interest-rate spreads against currencies with much lower interest rates such as the Japanese Yen or the euro. But when broad market sentiment toward emerging market risks turns, as is happening right now amid all the mayhem being triggered by the global response to the coronavirus, these currencies are particularly prone to capital outflows.

Mexico also has another big disadvantage in moments like these: It has one of the most liquid currencies and one of the biggest bond markets among emerging economies. It is also traded around the clock and has a high correlation with other Emerging Market. And it’s used in instruments designed to hedge against EM weakness. And that weakness is coming back to the fore right now.

If other peso crises are any indication, it’s not just foreign exchange traders after a quick buck that are betting against the currency. So, too, probably, are Mexico’s biggest banks and institutional investors. During the last peso crisis, an estimated 75% of transactions of pesos into dollars were being executed by big institutions and banks, mainly Mexican.

Many large Mexican businesses are in the same group. As I wrote in a July 2015 article, “it is the worst of vicious circles: the stronger the dollar gets, the more the locals want it. The more the locals want it, the weaker the peso becomes. Rinse and repeat.”

Neither the peso’s last collapse nor this latest one are a reflection of the current state of Mexico’s economy; they are the result, primarily, of economic and financial forces taking place far beyond Mexico’s borders. That said, each time the currency weakens, it heaps further pressure on the economy. And that economy is already in the doldrums.

Continue reading the article on Wolf Street

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