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Bearish USD/MXN on Positive Oil Correlation To Hedge Possible Oil Turning

Bearish USD/MXN on Positive Oil Correlation To Hedge Possible Oil Turning

Tyler Yell, CMT, Currency Strategist


Point to Establish Long Exposure: At Market ( 1.6460)

Spot: 18.6973

Target 1:18.3003 (November 8 Close)

Target 2:18.0506 (August 16 Close)

Invalidation Level:19.2371 (March 22 High / March 15 Close)

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Fundamental & Technical Focus:

Two key themes turn our focus toward USD/MXN. USD has been quietly losing to high-yielding currencies after the Federal Reserve failed to raise their Dot Plot. The market seems to be settling back into a Goldilocks zone of no significant event risk and stable views from Central Banks that could inflate the hunt for yield that benefits Emerging Markets.

On example of this yield-hunt is in South Africa, despite political instability. On Wednesday, reports showed the large-scale institutional buying of South African bonds where demand outstripped supply 6-1 per Bloomberg, which seems to argue the FX effect (USD/ZAR) higher may not hold. On Tuesday, net inflows reached 4.9 billion ZAR ($375 million), the most since June, according to JSE Ltd. Data.

Similarly, options traders appear to be betting the impact of the political turmoil will blow over as one-week implied volatility spiked to a four-month high this week while the rise in 12-month contracts was subdued. The options market reaction appropriate and encouraging to the view the high-yielders could continue to perform.

Why USD/MXN? MXN seem to be benefitting not only from its high-yield status, which Banxico has supported by raising rates lately but via a correlation to Oil. If Oil can turn around, which would likely happen on the back of a weaker USD, we could see a further breakdown in USD/MXN that would benefit this trade.

This trade could flop if a risk off event takes money out of EM and money seeking high-yield begins to seek safety or if the USD reverses course and begins to appreciate. However, absent a reversal in these two trends, I anticipate further MXN appreciation against USD.

The chart below shows the strong appreciation of the MXN with the price of Oil overlaid in Orange. The technical indicator, Ichimoku is showing a bearish breakout per the lagging line that I anticipate preceeding more downside toward the November 8, and August 16 close.

Favorable Correlation Could Help MXN Long Trade:

Created by Tyler Yell, CMT


Happy Trading!

Tyler Yell, CMT

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.