Jan Dehn, head of Research at Ashmore, explains how Mexico taught currency speculators a lesson last week. Elsewhere, Argentina took a significant stride forward in the holdout case and Venezuela’s actions say far more about the government’s willingness to pay than its ability to pay. Brazil was downgraded again – but the time to sell was a long time ago.
Mexico talks back to speculators
What do global currency traders do when global risk aversion rises? Answer: They sell Emerging Markets (EM) currencies, in accordance with long-established, but completely nonsense rules of thumb.
When they do so, however, they prefer to sell the largest and most liquid EM currencies. Large liquid EM currencies can be traded in size and they are perceived to be ‘safe’ from government intervention. This is why MXN along with China’s CNH have become particularly popular targets for speculators, despite the fact that risk aversion is rooted in uncertainty about the US outlook.
This week, however, the Mexican government showed that it has had enough of this mindless speculation. Believing, rightly in our view, that the sell-off in MXN has become excessive relative to Mexico’s solid economic fundamentals – indeed even beginning to pose a threat to the latter – the government reminded markets that Mexico has considerable means at its disposal to inflict damage on speculators.
First, the central bank hiked rates by 50bps, taking policy rates to 3.75%. The move is not the start of a hiking cycle. Second, the government cut spending by 0.7% of GDP, with most of the cuts coming through efficiency savings at PEMEX, the massively inefficient state-owned oil company.
Third, the central bank dropped its rule-based intervention framework in favour of a discretionary one. Mexico has USD 175bn in FX reserves plus access to USD 65bn via a Flexible Credit Line and USD 40bn via a Fed swap line.