The Banco de Mexico (Banxico) has announced that it will offer FX hedging instruments to the market for up to US$20 billion, a move that led to a bounce in the peso and has gained approval from some local economists.
Banxico’s Foreign Exchange Commission (FEC) did not specify the exact details of the instruments that will be offered, stating that the first auction will take place on March 6 for up to US$1 billion and will be settled in Mexican pesos.
The central bank said that the specific details of this offering will be included in the announcement of this auction in the near future.
“It is a positive development and an important change in FX policy. It should help to stabilise the MXN down the road. The central bank definitely had a debate on this for sure, as Mexico has been married to the flexible exchange regime in the most orthodox manner. It should put a ceiling to the USD/MXN,” says Marco Oviedo, director of emerging markets research at Barclays in Mexico.
Similarly, Daniela Blancas, financial market economist at CitiBanamex, praises the decision.
“This is a good measure,” she says. “[Banxico] have done this because they decided that the recent interventions in the FX market have not had the results that they wanted. Therefore, they’ve had to be more creative and think outside the box about different mechanisms that could help mitigate some of the recent currency volatility.”
The broad guidelines in the Banxico communique? state that financial institutions in Mexico will be able to bid for these securities, which can then pass the exposure to market participants, so the latter group will be able to take advantage of the new facility indirectly.
Hedges will be in the form of NDFs with future payments netted in pesos and, because all payments will be settled in local currency, it means that these transactions will not require selling dollars to counterparties from Mexico’s international FX reserves.
However, it says that the exact dates, amounts, and characteristics of the auctions of hedging instruments will be determined based on the evolution of market dynamics, providing the FEC with flexibility to adjust them as they see fit.
According to the announcement, hedging instruments will have a maturity no longer than 12 months and Banxico will rollover the full amount of maturing instruments until the FEC judges it as desirable.
Blancas notes that although the use of NDFs is nothing new for the Mexican FX market, it is the first time that the central bank has used these products to achieve exchange rate policy goals.
“I think that this is just another way of doing an FX intervention, another new channel for how they can manage the FX market and it will have a positive impact on the FX market,” she says.
The new measures have forced analysts at Banorte to revise a number of their forecasts for the year ahead.
The Mexican bank now expects a +100bps hike for the reference rate during the rest of the year, down from its prior +150bps assessment.
“Given the FEC’s announcement, the central bank now has greater leverage to execute monetary policy due to fewer inflationary pressures derived from the reduced volatility of the exchange rate coupled with lower energy prices. In addition, the implementation of the exchange rate hedge program is also likely to lead to lower short-term inflation expectations. In this context, we consider that the central bank will increase the reference rate by 100bps throughout the remainder of the year,” the analysts say in a report issued after the Banxico announcement.
The USD/MXN cross plunged from 20.40 to 20.00 and even reached 19.93 on an intraday basis, with the peso ending 1.8% stronger on the day and at its strongest level since the US election.
Meanwhile, forward points up to the one-year maturity decreased heavily following the rally in spot. Nevertheless, and as of the local session close, carry gains in peso longs were broadly stable, with the three-month maturity at 5.3%.
“We maintain a cautious outlook on the Mexican peso, but adjust our year-end USD/MXN forecast to 22.30 from 23.50. We believe the decision is positive as it adds to the existing toolkit of the FEC (with discretionary USD sales in spot still possible), signaling that further and more innovative steps could be unveiled if needed. Moreover, it helps restore the separation between interest rate and FX policy. Notwithstanding, accumulated rate hikes by Banxico since December 2015 have significantly increased the cost of short MXN positions relative to other EM, reducing its attractiveness as a hedge,” say the Banorte analysts.
Overall, they predict that the Mexican peso is “poised to face a difficult year ahead”, because of heightened uncertainty relating to both external factors – such as the Trump administration, potential US rate hikes, and European elections, as well as such local challenges as a lower growth environment, higher inflation and less policy room in terms of fiscal and monetary policy flexibility, the structural downtrend in oil production, potential downgrades of the sovereign rating, and uncertainty about the upcoming Mexican presidential election in 2018.