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Article / 27 September 2016 at 23:20 GMT

Donald Trump didn’t dump the peso – Mexico did

Blogger / MoreLiver's Daily

  • The Mexican peso’s weakening has raised alarms and is being blamed on Trump
  • In fact, the peso is a classic devaluation play 
  • There is room for the MXN to rally but the longer-term outlook is bearish

By Juhani Huopainen

The first US presidential debate between Hillary Clinton and Donald Trump was aired on Monday. Most commentators have said Clinton performed better, and the market reaction seems to confirm that view – stocks rallied and the Mexican peso strengthened. The assumption is that Trump would be more protectionist in his relations with Mexico and his other economic policies would be, if not clearly worse, at least more uncertain than Clinton’s.  

Most of the Trump criticism is well-founded, but don't blame him for the peso. Photo: iStock

Firstly, after seeing how much the mainstream media despises Trump, I doubt they are able to maintain their objectivity. I think most of the criticism is well-founded, but perhaps the commentators are just repeating their previous views that Trump thrives on spreading half-truths and scaremongering. If you despise the style in the first place, you are bound to dislike it when seeing it again. 

The key question is not whether the Washington Post’s journalists liked Trump’s performance, but how the voters liked it. Some Trump voters might readily accept that Trump loses a debate, thus making polls of a single debate less meaningful for the actual election. All I’m trying to say is that the celebrations over Clinton managing to secure a lead might be premature.

As the November 8 election day gets closer, and with no other major risk events on the calendar, a lot of the market moves will be blamed on the US presidential elections. Opinion polls and real-time estimates of popularity will be major factors. Revelations of both candidates' most probable policy will matter.

One financial asset that has been said to move hand-in-hand with the opinion polls is the Mexican peso (MXN).  The logic is simple – Trump has talked about building a wall, kicking illegal immigrants out and changing the trade agreements. If the US succumbs to such protectionism, Mexico would be the hardest hit. I doubt that many of the readers here are active in the MXN, but the MXN could be a better indicator than the betting markets, and the eventual result of the presidential election has consequences for other asset markets as well.

In the coming days I will discuss the impact of the two possible results and present some of my thoughts, but for now I will concentrate on the MXN alone.  

The Mexican peso reached its weakest point ever against the USD, as USDMXN reached a high of 19.92 on Monday. The pair then plummeted on Tuesday after the first presidential debate was over. Among many others, Nordea and The Financial Times noted that Trump’s poll ratings and the USDMXN tend to follow each other.

The FT’s chart shows Trump’s chance of winning rising rapidly in July, but the MXN hardly moved at all. As Trump’s chances then fell towards the end of July, the USDMXN fell, and started rising together with the odds in mid-August.

Nordea’s chart shows bad timing – the USDMXN fell in mid-February, but Trump’s support started falling in mid-March. In May-July, the support numbers varied widely, but the USDMXN remained relatively unchanged. In mid-August both Trump’s support and the USDMXN turned higher at the same time.

Maybe the relationship between the US polls and the USDMXN is spurious. Maybe the correlation is really not there, or at a minimum, there are periods when there is no correlation.
First, let’s look at emerging markets-currencies and the MXN. CEW is The WisdomTree Emerging Currency Fund ETF, a US-denominated fund that invests in EM currencies. The relative performance chart shows how the MXN has tracked the CEW closely. The MXN’s decline in value is mostly related to a long-term bear market in the EM currencies, but in 2016 something changed. Emerging currencies started strengthening, but MXN continued weakening.

Emerging currencies and MXNUSD, change since 2009:
 Chart source: Saxo Trader

Emerging market-currencies and MXNUSD from the beginning of 2016:  MXN underperformed at the start of the year, then in May-June and recently in September:
CEW MXN short
Chart source: Saxo Trader

Looking at the presidential poll data, Clinton’s lead over Trump was small at the beginning of 2016, rose in March, then fell in May-June. Clinton’s lead was again small in August, and low in September.
Chart source: ClearWater Politics

The commitment of traders' reports shows that speculators were hugely short the MXN at the beginning of 2016, heavily short in May-June and hugely short in September:
MXN commitments
 Chart source: Scotiabank

Mexico is a notable oil producer and a net exporter. The price of the WTI crude oil and the MXNUSD move hand-in-hand, but for some reason at the beginning of 2016 the MXN did not strengthen as oil prices bottomed and rose from below 30 to 50. Instead, the MXN continued weakening.

MXN oil
 Chart source: SaxoTrader

The daily candlestick chart of USDMXN shows a rising trend, which had twice stopped at the 19.6-level:
USDMXN daily
 Chart source: SaxoTrader

Seemingly, Mexico’s central bank wanted to defend the 20-level, but in September the rate rose to a new all-time high. The previous intervention by the Mexican central bank was made in February, and the bank hasn’t intervened since. After lowering rates since the financial crisis begun, the central bank started hiking rates in December 2015, and has since then delivered two rate hikes. This has increased the short-term interest rates to 4.6% – much higher than in the US, making it more expensive for speculators to keep their MXN shorts open against the USD.
There are two ways to see this technically. The first one would be to assume that the rise above the 19.6 was a break of an important resistance level and a sign of trend continuation. The other way is to assume the pair is currently overbought and a return to the trendline around 18.5 should be waited for before going long USDMXN. I believe the latter choice is correct. Even a brave USDMXN short (a long MXN) could be a reasonable tactical bet, especially for the positive interest rate carry.

Looking at the very, very long chart shows that Trump didn’t dump the peso. It was Mexico’s fault all along. When I started in the markets in 1991, the USDMXN was trading below 3.0. The current big move is the third crisis move, and we’re now close to 20.
 Chart source: Create your own charts with SaxoTrader; click here to learn more

It wasn’t because of Trump. It was because Mexico suffers from a current account deficit and still historically-low oil prices. This drives MXN weaker. But speculators have had a harder time remaining short as Mexico’s one-year yield is 4.7% and the US yield is 0.6%. An annual 4%cost-of-carry makes speculators nervous, as does the 20-level and a fear of a surprise intervention by the central bank.

Speculators aren’t stupid, and the large short commitments mean that there is room for the MXN to strengthen. If the MXN strengthens a bit to the trendline, don’t write Donald Trump off yet from your extensive list of worries.

-- Edited by Susan McDonald

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform
28 September
Patto Patto
nice work.........
28 September
Juhani Huopainen Juhani Huopainen
This very much reminds me of the time before the Brexit referendum. Traders following betting markets, which tend to be biased by participant's beliefs. A speculator that assumes financial markets are winnable and sometimes wrong but assumes betting markets are objective is a strange beast.

Overreacting to opinion polls and assuming perceived correlation is causality - or even seeing correlation when there necessarily isn't any - is also a mistake.


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