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Sacha Tihanyi, Deputy Head of Emerging Markets Strategy at TDS, explains that the Mexican peso has been a top performer supported by carry and a compression in volatility across Emerging Markert, and warns positioning now appears to be skewed long MXN at record levels, which leaves the peso open to a squeeze from not only Mexico-specific factors, but global macro factors.

Key Quotes:  

“MXN (and many Latam currencies, save for BRL) has been a top market favourite since the start of the year. If measured back to the start of December, when the market began to rapidly price out any Fed hikes for 2019, MXN is by far the best performing currency globally (EM or otherwise). Unsurprisingly the move in spot also coincided with the beginning of a substantial move into MXN longs amongst the investment community, if we take the CFTC non-commercial positioning data as a general proxy for investor behaviour. The general market features of high yield and collapsing volatility, along with a failure to see Mexican portfolio inflows maintain the substantial inflows of January, suggest that MXN buying has likely not been driven by Mexico-specific fundamental factors, but by the broad and substantial move into EM in January, on the back of financial factors.”

“Net-long speculative MXN positioning has hit its highest level since the Taper Tantrum, thanks to a collapse in gross shorts (that were only beginning to become more bold, until USDMXN collapsed towards 19.00 this week and washed them out). However, the main driver since the December rally has been the explosion in long positioning, with gross longs now standing at their highest level on record.”

“With positioning becoming so highly skewed, in the face of deteriorating fundamentals in Mexico and still well established political risk / fiscal regime uncertainty, MXN relies purely on a continuation in compressing vol and high carry. We expect the latter to be maintained for the duration of this year, but (in our view) it is not enough to offset any (currently unpredictable) politically-sourced shock, or sufficient to insulate the peso from its most skewed long positioning on record.”

“Furthermore, and this is the crucial point, should we not continue to see compression in EM vol, and divergence between broad USD direction and EM FX vol direction, MXN becomes increasingly subject (and sensitive) to external non-Mexico specific shocks. Thus less of a vol spike will be required to wreak havoc with long MXN positions.”