Rabobank said the Mexican peso has risen 3.57% versus the US dollar year to date, even as it has slipped on a month-to-date basis. The bank also reported that non-commercial speculators’ net-long MXN positioning has been edging lower, and it expects that contraction to continue as support from carry becomes less compelling.
The strategists pointed to narrowing interest rate differentials and rising implied volatility as factors eroding MXN carry attractiveness, while arguing the currency may still fare better than many peers on a relative basis. Banxico has cut the overnight policy rate to 6.50%; meanwhile, the market is pricing 34bp of hikes by year end, though Rabobank expects the central bank to hold. USD/MXN implied volatilities have moved sideways across the term structure over the past month, and the bank forecasts the pair rising towards 17.9 over a three-month horizon.
Signs of Peso Weakness and Shifting Momentum
The Mexican Peso has been a strong performer this year, but we see signs of this trend reversing as it weakens against the dollar. The current USD/MXN rate hovering around 17.20 reflects this recent shift in momentum. We believe this weakening is not a short-term blip but the start of a move higher over the next quarter.
The primary reason for our view is the diminishing appeal of the peso carry trade. While Mexico’s policy rate at 11.00% still offers a significant premium over the U.S. Federal Reserve’s 5.25% rate, the market is pricing in future cuts from Banxico while the Fed remains on hold. This narrowing of the interest rate differential reduces the incentive for traders to hold long peso positions.
Speculator Behavior, Volatility, and Positioning Strategies
We are seeing large speculators agree with this outlook, as they are reducing their bullish peso bets. The latest Commitment of Traders report from the Commodity Futures Trading Commission (CFTC) confirms that net long positions on the peso have fallen for the third consecutive week. This exit of institutional money often signals a more sustained currency depreciation ahead.
With the carry trade becoming less attractive, we expect currency volatility to rise from its recent lows. Three-month implied volatility on USD/MXN has already ticked up to nearly 13% from below 11% last quarter, making options a more valuable tool for managing risk. This suggests the market is starting to price in a wider range of outcomes for the peso.
Given our three-month forecast for USD/MXN to trade up towards 17.90, we think traders should position for further peso weakness. One strategy is to buy USD/MXN call options with strike prices around 17.50 or higher, which provides a way to profit from a rising exchange rate with a defined risk. This allows traders to capitalize on the expected upward trend.
Despite this view, the peso’s relatively high yield will still offer some support against other currencies, preventing a dramatic collapse. This means the move higher in USD/MXN may be gradual and choppy, similar to the volatility spikes seen during the 2024 election period. This environment favors strategies that can navigate swings rather than bet on a straight-line move.
