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Mexican Peso Outlook Improves amid Receding Political Risks, but Caution is Warranted

Mexican Peso Outlook Improves amid Receding Political Risks, but Caution is Warranted

Diego Colman,
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  • Mexico’s ruling party loses its supermajority in the Chamber of Deputies following Sunday’s midterms elections
  • Congress new composition will make almost impossible for the Mexican president to enact market unfriendly constitutional reforms
  • Receding political risks may support the Mexican peso in the short term, pushing the USD/MXN to lows not seen since early 2020

Most read: Volatility Plunges; USD Rangebound as US Yields Steady; US Inflation Data on Thursday

The Mexican peso has gained more than 1% against the US dollar this week, supported by receding political risks in Mexico following mid-term elections held last Sunday, in which voters headed to the polls to choose all 500 members of the Chamber of Deputies, several state governors and local lawmakers.

Although official results have not been announced yet, the preliminary tally by the electoral institute (INE) suggests that the ruling coalition party led by the National Regeneration Movement (Morena) has maintained control of the lower house, but has lost its supermajority necessary to enact sweeping legislative changes and ambitious constitutional reforms. As of this moment, the Morena led alliance appears set to garner 56% of all the 500 seats in the Lower House, far below the 67% required to achieve a “qualified majority”.

With the latest electoral setback, President Andres Manuel Lopez Obrador (AMLO) will struggle to extend its mandate in power beyond the six-year term allowed by the Constitution, but most importantly he will face stiff opposition in Congress to advance his populist and market-unfriendly initiatives included in his “Four Transformation” agenda.

All else equal, the new legislative constraints for the Executive branch may restore some investor confidence and lower risk premia, boosting investment and, by corollary, the Mexican peso, at a time when higher oil prices is already lending some support (rising crude prices, a top export for Mexico, increases national income and government receipts).

The stronger checks and balances at the legislative level, the improving economic backdrop aided by robust external demand and remittances, and the possibility of the Mexican Central Bank (Banxico) adopting a hawkish approach to contain rising inflationary pressures may reinforce the USD/MXN downward trajectory in the near-term. However, on a longer term horizon, US monetary policy and the Fed tapering process may be more relevant for the Mexican peso and EMFX in general, especially if a rapid and significant transition to higher rates materializes. For reference, during the start of the Fed's taper tantrum in 2013, between May 22 and June 25 of that year, the US 10-year yield jumped 68 basis points, while the real yield on TIPS climbed 100 basis points in the 10-year maturity. During those 5 weeks, the USD/MXN surged a whopping 7.2% from 12.33 to 13.23.

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Although the USD/MXN price action has moved horizontally since mid-April (sideways consolidation), bouncing between support and resistance, the underlying trend remains bearish medium term, a thesis supported by the presence of lower highs and lower lows in the daily chart.

To have conviction in the argument that the pair will continue to slide, we would need to see a decisive break below 19.55, where the 2020 year low converges with the lower slope of a short term descending channel. If bears manage to push price through that floor, the October 2019 low at the 19.00 psychological mark will come into play near term.

Alternatively, if selling pressure recedes and price manages to rebound off support, the USD/MXN could head higher towards the 20.25 level. A move above this resistance on a daily closing basis could expose the 200 day moving average near 20.45.

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---Written by Diego Colman, DailyFX Market Strategist

Follow me on Twitter: @DColmanFX

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