The Mexican Peso sharply appreciated this afternoon after Fitch raised the nation's sovereign credit rating one notch to BBB from BBB-. The rating house cited progress on the internal security front, macro-economic and political stability, and the Pena Nieto's ambitious reform agenda which has already passed sweeping education reform and now is looking to tackle the telecom and oil monopolies. The Peso surged nearly 1000 pips on the news, strengthening to a near two year high to 11.97 per USD. This also marks the first time USD/MXN has been under 12 since 2011. The techs are now salivating for chance to retest the 2011 low of 11.48. CTFC long/short data shows that speculators have already built up a huge net long position for MXN, while corporations have largely maintained their equally large short MXN position, presumably to hedge MXN denominated receivables. MXN is technically a mixed bag, but the fundamentals remain excellent. Therefore, USD/MXN is a sell on rallies. I maintain my 2-3 year target of 10, and expect this pair trade in the 11.10-11.25 range by year end.
Meanwhile, Governor Carstens of the Banco de Mexico may be regretting his calls for the rating houses to upgrade Mexico. Last Spring, when the Peso was tumbling with all EM currencies as the Grexit seemed inevitable, Carstens had hoped that an upgrade in light of Mexico's sound finances may help shore up MXN amidst terrified markets selling off nearly everything but USD and JPY. Today, the Bank is warning of 'hot money' inflows which may drive up the exchange rate short term but could cause a sudden crash should they stop or reverse. The recent upgrade should only further stoke foreign demand for MXN denominated securities, which is already at an all time high, thus exacerbating the 'hot money' problem. On monetary policy, the Bank faces a tough choice. Inflows from abroad typically drive inflation up because firms find cheaper financing as foreign investors pour money into local bond markets. However, any rate hikes make it only that much more attractive for investors to park money in Mexico.
Mexico is projecting an aura of vigilance. It is loathe to suffer the same fate as Brazil and Costa Rica, whose local money markets were flooded with foreign deposits as world investors chased yield. The result was high inflation that the central bank felt powerless to contain, lest it encourage even more short-term inflows. A key theme for MXN going forward will be how the central bank signals its policy as to what it may do if it determines that inflows have reached "critical mass." As long as Mexico continues its strong growth and maintains healthy public finances, the inflows remain largely in line with the fundamentals, for now.
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