FX5: Banxico – Biggest bang for their peso (MXN)

Thursday February 18: 5 Things that the markets are talking about

Despite a holiday shortened trading week, investors are having to deal with many moving parts – OPEC/Iran, EM Central Banks, EU/Brexit talks – to keep ahead. Market volatility is here to stay for some time, even the OECD and World Bank are concerned.

1. Chance for oil production deal drive markets

Hopes for an OPEC/non-OPEC crude production bargain continues to drive global equities higher. Oil prices are still trending upward, as Iranian officials appear to have given a “nod” to efforts to stabilize the market. Post-close API inventories in the U.S yesterday also showed a surprising draw. Even U.S treasuries have been sold off (10’s backed up +5bps to +1.84%. They are now +20bps higher from last week record low yields).

No sooner had Saudi Arabia, Russia, Qatar and Venezuela penned a provisional agreement to freeze oil production on Tuesday, OPEC ministers from Qatar and Venezuela went to Tehran to convince the Iranians to go along with the deal.

After the meet, the Iranian Oil Minister said his government “supports any effort” to stabilize oil market and prices, and supports cooperation between OPEC and non-OPEC countries, but it would “wait and see” what impact the meetings between OPEC and non OPEC countries have on oil prices before formally joining any deal. This was music to any crude bulls ears – but for how long?

For commodity currencies like the CAD, it has once again hitched itself to the oil wagon for the time being. The loonie surged yesterday as the dollar shred more than -1% (C$1.3670) as WTI ($31.27) found a bid. Dollar bulls continue to scratch their heads regarding CAD – if it’s not M&A, not oil, and not rate differentials its has been a lottery when plotting the loonie’s direction so far this year.

2. Biggest bang for their peso

After leaving rates unchanged at their February 4th meeting, the Mexico Central Bank (Banxico) took the market by complete surprise with yesterday’s announcement. One day after holding an extraordinary meeting (Tuesday) Banxico raised overnight rates by +50bps to +3.75% from +3.25%. It had been reported that Banxico had been selling USD as late as Wednesday morning.

The MXN weakness had increased the potential for knock-on effects for inflation. The peso has since rallied +4% outright on the surprise hike. Mexico central bank historically has preferred “rules-based” intervention, so yesterday’s move certainly took many by surprise. Later this morning the Banxico will publish the minutes from their meeting two-weeks ago. Oil and China remain key drivers; do not be surprised that yesterday’s hike, coupled with budget cuts, could put the brakes on Mexico’s growth.

Banxico is expected to only sell USD directly in the exchange market under “really exceptional conditions.” Direct intervention only comes about because the central bank and Minister of finance consider the exchange rate to be out of line with the country’s macroeconomic framework.

What arsenal Mexico deployed yesterday should reduce somewhat speculators incentives to position against MXN.

Other Latin American economies are taking a different route towards economic stability. In Brazil, equities have rallied hard after a central banker (Banco Central Do Brasil) there hinted that their next move could very well be a cut in the benchmark SELIC rate. However, gains have since been halved when S&P cut the country’s sovereign rating further into junk territory to BB from BB+; outlook negative.

In Venezuela, President Maduro has devalued their official FX rate for priority goods -37% to 10 VEF/USD from 6.3, effective today.

3. Odd’s for a December Fed rate hike increase

The mighty dollar is certainly benefitting from some rate differential love. Wednesday’s U.S industrial production data (Jan. PPI inflation readings ticked up from Dec. weak showing. Headline PPI was up +0.1% after declining -0.2% a month earlier, while the y/y measure was up to -0.2% compared to -1.0%) suggests that U.S growth is somewhat still resilient.

Fed fund futures (a proxy for central bank policy) indicate that there is now a +43% likelihood of a rate increase by the Fed at its December policy meeting. The probability of a Fed hike was straddling +12% at the beginning of this shortened trading week, while earlier this month, the odds had flat-lined.

The latest set of Fed meeting minutes released yesterday, predictably underscored increasing concern about the impact of global volatility on the U.S economy and inflation. Most members now judge that volatility has increased. A data dependent Fed is hard to read, expect heightened market volatility around every FOMC meet this year.

4. OECD Cuts 2016, 2017 Global growth forecasts

OECD cuts Euro Area 2016 GDP growth forecast from +1.8% to +1.4% and cut its global 2016 GDP growth forecast from +3.3% to +3.0% this morning. The organization indicated that the economies of Brazil, Germany and the U.S. are slowing and not surprisingly warned that some emerging markets (EM) are at risk of exchange-rate volatility.

“Financial stability risks are substantial,” the Paris-based organization said. “Some emerging markets are particularly vulnerable to sharp exchange-rate movements and the effects of high domestic debt.”

In its most forceful call to action since the financial crisis, the OECD said the global economy is suffering from a weakness of demand that cannot be remedied through stimulus from Central Banks alone.

With low global interest rates, governments should be practicing what they have been preaching – borrow more and put that capital to work.

5. Brexit talks begin

European Leaders begin a two-day summit today, seeking to keep the U.K within EMU – there is no guarantee of a deal.

Investors should expect the pending U.K referendum on whether to remain a member of the EU to weigh on the country’s financial markets for months to come. Many are assuming that the U.K will vote to remain in the EU; however, there is currently a 40% chance to a Brexit. Any sort of separation is expected to have a long lasting market impact.

Due to the uncertainty, demand is spiking for contracts that protect investors from a big move in GBP this summer. Dealers note that the cost of some options have hit its most extreme levels since Europe’s sovereign debt crisis. Implied volatility (vols.) has rallied +12% this week vs. +8.4% cost recorded two-months ago.

The GBP (£1.4323) is steady as EU leaders enter into this “make-or-break” summit on facing difficult compromises to keep Britain in the bloc and wrangling with Europe’s worst migrant crisis since World War II. To avoid a so-called “Brexit”, Cameron has four key demands – welfare restrictions to help curb immigration, safeguards for non-euro Britain, increasing EU competitiveness and an opt-out from closer EU integration.

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Dean Popplewell

Dean Popplewell

Vice-President of Currency Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell
Dean Popplewell

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