THE MEXICAN PESO WEAKENS AMID INFLATION UNCERTAINTY AND THE DIMINISHING APPEAL OF CARRY TRADES

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Written by Antonio Di Giacomo, Senior Market Analyst at XS

THE MEXICAN PESO WEAKENS AMID INFLATION UNCERTAINTY AND THE DIMINISHING APPEAL OF CARRY TRADES

The Mexican peso resumed its losses on Tuesday, October 13, in a session marked by the return of liquidity following the U.S. holiday and position adjustments ahead of the next U.S. inflation report. During early trading, the exchange rate stood at around 18.39 pesos per dollar, with the peso depreciating 0.65% after approaching 18.40. The move reflects greater caution toward the Mexican currency amid uncertainty over interest rates.

Th’ peso’s weakness stood out because it occurred while the dollar was declining against other major currencies. At the same morning snapshot, the dollar index fell 0.39% to 102.19, without providing support for the Mexican currency. This divergence suggests that pressure on the peso also reflects factors related to the appeal of investments in Mexico and reduced exposure to emerging market currencies.

The return of market participants allowed more active trading after a lower-volume session due to the U.S. holiday. When liquidity normalizes, investors can execute previously postponed transactions and adjust their hedges ahead of significant events. This time, that process coincided with stronger demand for dollars against the peso, although a single session’s performance does not yet confirm a sustained trend.
One of the main factors behind the currency pressure is the reduced appetite for carry trade strategies. These transactions seek to capitalize on interest rate differences between currencies by borrowing in a lower-yielding currency and investing in another that offers higher interest rates. However, when the peso weakens, its depreciation can reduce or even outweigh the gains earned from that differential, making the strategy less attractive.

The possibility of Me’ico’s interest rate advantage over the United States narrowing keeps attention focused on both central’banks’ decisions. If Banxico finds room to lower its rate and the Federal Reserve raises its rate again, the relative return on peso-denominated instruments could deteriorate. This scenario still depends on incoming economic data, but the possibility alone may prompt investors to reduce exposure before it materializes.

The next catalyst will be the U.S. inflation report for September, scheduled for Wednesday, October 14. Market participants will assess both the headline figure and the core measure, which excludes food and energy, to determine whether price pressures remain persistent. A higher-than-expected reading could reinforce expectations of tighter monetary policy and increase volatility in the foreign exchange market.

If inflation surprises to the upside, the market could assign a higher probability to another Federal Reserve rate increase before the end of the year. That could push U.S. yields higher and increase their appeal relative to alternatives denominated in emerging market currencies. Conversely, a more moderate reading could ease some of the pressure on the peso, although its recovery would also depend on global risk appetite.

For the Mexican economy, persistent depreciation poses an additional risk because it raises the cost of imports and dollar-denominated inputs. However, the pass-through from exchange rate movements to prices depends on how long those movements last’ companies’ hedging arrangements, and demand conditions. Banxico will need to assess these factors alongside domestic inflation trends when deciding its next monetary policy moves.

In the short term, the 18.40 pesos per dollar area is drawing attention because of its proximity to the levels reached during the morning. A sustained move above that level could set up a test of 18.50, while a return toward 18.20 would signal easing of recent pressure. These levels serve as scenarios to monitor and will depend on the response to the inflation data, U.S. yields, and flows into Mexican assets.

In conclusion, the Mexican peso faces caution ahead of U.S. inflation data and the diminishing relative appeal of carry trade strategies. Its decline, despite the drop in the dollar index, shows that the exchange rat’’s trajectory also depends on expectations for the interest rate differential and the risk investors are willing to assume. Wednes’ay’s report will be key in determining whether the dollar extends its advance toward –8.40–18.50 pesos or whether the Mexican currency finds support to regain ground.

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