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Mexican Peso Weekly Forecast: U.S. Inflation Data May Spark a Rebound in USD/MXN

Mexican Peso Weekly Forecast: U.S. Inflation Data May Spark a Rebound in USD/MXN

Diego Colman,
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  • USD/MXN has fallen significantly since the November high, but the tide may be about to turn amid rising U.S. Treasury yields
  • Expectations that the Fed will be aggressive in fighting inflation should boost the dollar in the near term. That said, all eyes will be on the December CPI report in the week ahead
  • The Mexican peso, meanwhile, faces another headwind: uncertainty over monetary policy amid the central bank's new leadership

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The Mexican peso has strengthened significantly over the past few months, with USD/MXN falling from 21.55 in late November to 20.36 sometime this week. However, the trend may soon change, as the near-term outlook for the U.S. dollar is looking increasingly bullish on account of monetary policy developments in the United States.

Currently, the market sees the Fed delivering three interest rate increases this year, but a fourth hike is slowly creeping into expectations following the release of the December FOMC minutes. As a reminder, the minutes showed that the central bank is leaning towards raising the federal funds rate sooner or at a faster pace than initially envisioned to tackle red-hot inflation. Policymakers also appeared on board to begin trimming the bank's portfolio soon after liftoff, signaling that the balance sheet runoff may proceed much more quickly than in previous episodes, a positive scenario for the U.S. currency.

The Fed's hawkish stance will boost the appeal of the U.S. dollar in the forex market in early 2022 by putting upward pressure on bonds rates. In fact, yields could stage the next leg higher in the coming days after we get the latest inflation reading. We should have that information on Wednesday, when the U.S. Bureau of Labor Statistics releases last month's report on consumer prices. That said, December headline CPI is expected to accelerate to 7.1% y/y from 6.8% y/y in November, its fastest pace since 1982.

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With inflation showing few signs of easing and at multi-decade highs, investors are likely to raise bets that the Fed will become more aggressive in pulling back support to achieve one part of its mandate: price stability. Monetary policy repricing can quicken the upside moves in yields (for reference, the 10-year briefly reached 1.8% on Friday, the highest level in two years), bolstering the greenback and dragging down other currencies whose central banks have yet to embark on forceful normalization.

In Mexico, the central bank has already raised interest rates multiple times in 2021, but the tightening cycle could become shallower or even come to a screeching halt amid new leadership. Some investors speculate that Banxico's new governor, Victoria Rodriguez Ceja, will steer monetary policy in a dovish direction, prioritizing economic growth over inflation control, but we don't yet know much to make broad conclusions about the outlook. However, this uncertainty, coupled with Fed developments, should weigh on the Mexican peso over the next few weeks.

In terms of technical analysis, USD/MXN has corrected downwards in recent weeks and is now approaching a critical floor in the vicinity of 20.25, which corresponds to the 200-day SMA. At the same time, the 10-day RSI is drifting into oversold territory, a situation that could pave the way for a rebound from current levels in the coming sessions. If bulls regain control of the market and the exchange rate pivots higher, resistance can be seen at the 2022 high near 20.76, followed by 20.85, the 50-day SMA.

However, if sellers continue to push the price lower and the 20.25 area is breached decisively, USD/MXN could be on its way to test rising trendline support and the October low near 20.10 in a matter of days.

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USD/MXN chart prepared in TradingView


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---Written by Diego Colman, Contributor

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