Emerging Market FX: Real Realities & Poised Peso

In this weeks segment I want to take a look at the Latin American emerging market FX landscape, in previous reports I introduced the Brazilian Real, this week I want to review its closest Emerging Market counterpart the Mexican Peso.

Real Realities

Before delving into the fundamental backdrop in Mexico lets quickly review the Brazilian news flow and any potential near term trading opportunities that may be developing.

The major news event of the week is Wednesday’s central bank meeting. Brazil’s central bank will most likely keep the policy rate unchanged at 14.25% on Wednesday. Inflation (10.3% in mid-Novemebr) is running well above the 4.5% (+/-2ppt) target, but with real GDP set to shrink by more than 3% in 2015, the central bank is unlikely to act with a hike before year end.

One of the principle challenges to the central bank is the fiscal cost of using swaps to stabilize the BRL is soaring. For now interbank dealers report that the BCB is intervening directly by selling USD, but the BRL is vulnerable to a change in investor sentiment, potentially prompted by rumors of the replacement of Finance Minister Levy due to disagreement on how to handle the weak state of local government finances, or a financial aid package to Petrobras, matters discussed in our previous review that continue to remain unresolved.

brl

From a trading perspective we are testing the initial support zone that we highlighted in our last review and have seen some initial support develop with buyers emerging at a retest of the prior lows. Above is the previous chart below is where we stand going into the central bank meeting today.

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  • My trade plan with the USDBRL is to venture long through 38000 stop below 37400. Note I will not enter this trade prior to the central bank release. You will note from the chart that this trade is supported by positively orientated psychology and linear regression indicators.

Poised ‘Mexican’ Peso

The Mexican Peso is the national currency of Mexico originally formatted on the Spanish Peso. The Mexican currency was premised on eight real silver coins issued to the Mexicans by the Spanish. The coins were minted from pure silver retaining a very specific weight and disguised border pattern to protect against counterfeits.

The Mexican economy like most Latin American counterparts was born out of agricultural that developed into a manufacturing base that rapidly moved towards a commodity driven base, in Mexico’s case specifically oil and mining have been significant contributors to the GDP especially since joining the North American Free-trade Agreement.

Today the economy is the 15th largest in the world on a nominal basis and eleventh by purchasing power. In recent years the expansion of the industrial and services sectors has been notable with the government encouraging competition in ports rail, telecom’s, electricity and natural gas distribution sectors.

From a political perspective the country retains a more stable political landscape than most of its neighbours in recent national polls the President Enrique Pena Nieto rose to 42% in November from 35% registered in the same poll in August. It appears the recovery in ratings has primarily be attributed to the dissipation of national concerns regarding the escape from prison of the notorious drug kin ping ‘El Chapo’.

From an economic perspective as with most emerging market players the current driver is the much anticipated and increasingly likely US FOMC rate move and the domestic central banks potential policy response to warn off rapid domestic FX devaluation.

The central bank of Mexico left rates unchanged at 3.0% at its October meeting. In its policy statement, the central bank recognized that balance of risks for the global and Mexican growth outlooks had deteriorated in the last month, while those for external and domestic inflation had remained unchanged. The fact that bank sees a worsening in local economic conditions is meaningful, as it suggests that the authorities are concerned with the soft manufacturing export data witnessed of late and that these concerns outweigh the solid expenditure numbers posted by the consumer.

The most noteworthy aspect of the recent statement is that the central bank does not appear to buy into the recent rebound in Emerging Market asset prices and warns that it could revert in coming months. Interestingly, the catalyst for increased market volatility is no longer just the prospect of Fed tightening or Europe slowing, but also Emerging Market-idiosyncratic risks coming from China and/or Brazil. And if such volatility materializes, the statement adds, the Mexican authorities should stand ready to act, through a commitment to a responsible fiscal stance and through the use of monetary policy if need be.

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From a trading perspective the Peso is mapping relatively closely the pattern in the USD and BRL we appear to be in a similar holding pattern developing a wedge scenario that should at a minimum witness an exhaustive thrust, most likely topside in this instance.

The broader pattern I prefer to map in this instance is highlighted on the weekly chart above.  Please remember this is just price mapping, developing a probable path for price, I do not enter trades based on this chart work.

So lets drop down to a trading time frame and see where the near term opportunities may be developing. On the daily chart, if we anticipate a period of consolidation to materialise in advance of the December FOMC meeting, I would be inclined to buy weakness towards 16.5/16.4. Looking for an upside  thrust to retest and break highs into year end early 2016

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Open Emerging Market FX Trades

Long USDINR 65.25 Stops To Entry, First Target Achieved at 66.85, stay long to target a retest and break of year to date highs next

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For updates on trade of the day set ups and the other trades I am currently monitoring be sure to follow me on Twitter @LFXPatrick