Against a backdrop of rapidly rising US interest rates and mounting recession fears, most currencies weakened significantly against the US dollar in 2022. However, the Mexican peso was one of the outliers, appreciating 5% in 2022 and now trading below 19 per US dollar, a level not seen since February 2020, with a 3.6% gain this year.
What can explain this appreciation? The peso was highly exposed to global risk sentiment and liquidity conditions in 2022, but according to analysts, four idiosyncratic factors more than offset this reality. As we enter 2023, these factors will continue supporting the peso, particularly during the year’s first half.
1. Interest rate differentials: Banxico began raising the reference rate in June 2021 to cushion the impact of the Fed’s rate hike. After a 650 bps (6.5 pp) rise, it is expected that Banxico is close to the end of the hiking cycle. However, the rate differential is expected to hold.
2. Positive impact of a relatively resilient US economy: The strength of the US economy in 2022 increased demand for manufacturing exports and boosted remittances from the US to Mexico to record levels. The slowdown of the ‘northern neighbor’ that we expect in 2023 should moderate remittances and the growth of manufacturing exports from very high levels.
3. Stable fiscal position and robust institutional framework relative to peers: Mexico’s credit outlook compares favorably with most of its Latin American peers, given its fiscal stance. Mexico faces several medium-term fiscal challenges, although these will likely be on investors’ minds this year, as its fiscal accounts remain strong relative to most emerging countries.
4. Constructive narrative of nearshoring: Mexico benefits from nearshoring as US companies try bringing production closer to home. According to estimates by the Inter-American Development Bank, Mexico could generate US$35bn per year in additional revenue from exports of goods through nearshoring in the coming years. While it may be too soon to assess the impact of this phenomenon on Mexico’s long-term growth, we believe it offers a positive narrative in investors’ minds.
As for the risks it faces, the possible consequences of a trade dispute with the United States and Canada stand out in the context of alleged violations of the USMCA in energy matters, which must be monitored. Also, a deterioration in investor confidence in the face of a larger-than-expected US recession could significantly damage the Mexican economy.
Reference rate trajectory (%) in Mexico and the United States post-pandemic
