Mexican Peso Retains Positive Outlook, but Near-Term Weakness Cannot Be Ruled Out

(MENAFN- DailyFX) MEXICAN PESO OUTLOOK:

• Slowing inflation in the U.S. may lead the Fed to wait more before reducing policy accommodation
• More patience by the central bank may keep US treasury yields depressed for longer, weigh on the dollar and boost EMFX such as the Mexican peso heading into the fourth quarter
• While the Mexican peso maintains a positive outlook over the medium term, near-term weakness cannot be ruled out on rising odds of an equity market pullback

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U.S. inflation undershot expectations in August, suggesting that upward price pressures are finally starting to ease after supercharged readings in the early summer. According to the Bureau of Labor Statistics , headline CPI rose 0.3% m/m, the slowest increase since January, bringing the annual print to 5.3% from 5.4% in July. Meanwhile, core CPI, which excludes food and energy items, climbed 0.1% m/m and 4.0% y/y, two tenths of a percent below forecasts in both cases.

It is too early to declare victory, but cooling inflation, especially in the core component, plays nicely into the transitory argument and indicates that the worst may be over, a scenario that would give policymakers more cover to be patient before removing accommodation. In layman's terms this means that the Fed may be inclined to wait a bit longer, perhaps until December, to officially announce a plan to taper asset purchases, even more so now that the labor market has softened on delta-variant worries. For traders, more patience likely portends lower Treasury yields for longer, a negative outcome for the U.S. dollar over the medium term.

In turn, a low rate backdrop in the United States may benefit EMFX, particularly those currencies with an attractive carry such as the Mexican peso. However, for MXN to strengthen in this environment, risk-appetite needs to remain supportive.

For now, it is hard to say whether sentiment will stay on the positive side, especially as strategists continue to warn of a potential correction on Wall Street on seasonality, elevated valuations, stretched positioning and the threat of higher corporate taxes . A pullback in equity markets may activate a flight-to-safety move and wallop EMFX across the board, triggering a temporary spike in the USD/MXN exchange rate. For this reason, staying away from riskier currencies over the next two weeks, or at least until the direction of the US economy becomes clearer, may be a good approach for traders who don't like unexpected bouts of volatility.

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Following the late August/early September sell-off, USD /MXN has been hovering above a key support in the 19.80 area without much action in recent days. For bears to regain control of the market and stage the next leg lower, we would need to see a sustained move below that level in short order. That said, if the pair manages to pierce this floor in daily closing prices, the 2021 low at 19.65 would become the immediate downside focus, followed by the 19.00 psychological mark.

On the flip side, if risk-aversion awakens strong volatility and USD/MXN spikes higher, the first resistance to consider appears at 20.10, near the 200-day moving average. A move above this ceiling could easily rekindle buying-interest and push price towards the next resistance at 20.35, a technical barrier created by a medium-term descending trendline in play since June 2020.

Source: TradingView

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---Written by Diego Colman, DailyFX Market Strategist

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