USD/MXN Outlook: Debt Rating Downgrade May Bring Further Weakness for the Peso
Main USD/MXN Talking Points:
- The US Dollar retreats after continued Central Bank and government stimulus reignites risk-appetite
- USD/MXN dips below 23 but regains upward momentum as Mexico receives a credit downgrade
Another week of heightened volatility comes to an end and the USD/MXN regains a slight uptrend after a step-back during the week. The US Dollar has been steadily losing ground against G10 currencies as governments and Central Banks pledge unprecedented levels of fiscal and monetary stimulus to combat the impact of COVID-19 on the world economy. This has caused weakness in the dollar as investors recover an appetite for risk and undo some of the flight to safety trades we have seen in the last few weeks.
The continued support from the Federal Reserve has also caused the dollar to retreat against emerging market currencies, usually considered to be highly risky and strongly correlated to growth. After a period of relative stability had seen EMFX push higher before the COVID-19 outbreak took place, USD/MXN reached an all-time high last week when the exchange rate surpassed the 25 pesos per dollar mark. This week’s price action has seen the pair dip below the 23.00 handle, but Friday’s trading session has seen a small rebound back towards 23.50.
But more bad news lies ahead for the Mexican Peso, as S&P Global has downgraded Mexico’s long-term debt rating from BBB+ to BBB given the significant impact that COVID-19 is expected to have on its economy. Not only has the credit rating agency downgraded its rating it has also set the rating outlook to negative, which points to another possible downgrade in the next 12 to 24 months.
This has placed Mexico’s rating to just two categories above what is considered to be a speculative investment, causing concern amongst investors. Up until recently, the Mexican Peso has been benefiting from a high inflation-adjusted carry trade, even after a series of continuous rate cuts by Banxico, which has left the current rate at 6.5%, the Mexican Peso is still able to offer much better returns than most other currencies. But this rating downgrade could reduce the investment flow towards the Mexican Peso, which would in turn appreciate the USD/MXN exchange rate.
In their statement, S&P Global pointed out that potential increases in the energy sector's contingent liabilities could worsen the sovereign's debt levels and lead to subsequent downgrades. The financial profile of Pemex, a government-owned oil company, has weakened significantly over the past five years and has become more vulnerable in the midst of declining oil prices, which could have a large impact on the country’s rating.
USD/MXN FORECAST AND ANALYSIS
The push above 22.05 saw USD/MXN create an all-time high which did not stop until just below 25.50. Looking at the daily chart we can see how Thursday’s price action stopped just above the Fibonacci retracement of 38.2% from the multiyear highs, bouncing back around the 22.85 level before continuing higher and regaining the 23.00 handle. If bears manage to regain the upper hand, we could see some resistance around this 38.2% retracement level at 22.74, on its way to the next Fibonacci level at 21.94.
On the upside, the overnight session has seen some resistance at 24.05 which could be re-tested if the 23.6% Fibonacci level at 23.84 is cleared.
USD/MXN DAILY PRICE CHART (NOVEMBER 2019 – MARCH 2020)
--- Written by Daniela Sabin Hathorn, Junior Analyst
Follow Daniela on Twitter @HathornSabin
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