​Press Room

Who’s the currency piñata now?


Matthew Chapman
Mar 31, 2016
Among emerging market currencies Mexico bares even more of the brunt of heightened volatility than the rand.

The South African rand has come under immense pressure over the past 12 months; shedding some 30% of its value against the US dollar. It has become rather easy for the market to lay the blame at our government’s door and to, in particular, bemoan the questionable decisions of the presidency and his ‘advisors.’

Whilst there is no doubt that localised factors play a large part in the recent gyrations of the rand, South Africa is one of the most liquid and accessible currencies available to trade globally, and is often used as a proxy for emerging market (EM) risk on/risk off trades. As much as the rand feels the effect of recent heightened volatility in developing nations, there are other emerging market currencies who bare even more of the brunt, most of all Mexico.

The Chinese stock market rout, the Greek debt crisis, heightened fears of a Venezuelan debt default and speculation of a Federal Reserve rate hike are all examples of global economic conditions that have, arguably, affected the Mexican peso more than its emerging market peers.

Just like the rand, the peso has seen rapid deprecation over the past year, albeit half of that of the rand at just 15%. This however, in stark contrast with the rand, is on the back of strong economic fundamentals: Mexico is enjoying its lowest inflation figures in 47 years coupled with accelerating annual growth rates reaching 2.6% over the last three years.

Much of this economic growth occurred despite weak oil prices which provide for 20% of annual public revenue*. In South Africa, inflation is rapidly advancing upwards of 7%, well out of the SARB’s target range whilst economic growth continues to stutter; slowing to 0.6% in Q4 of 2015. Alongside this Mexico has a credit rating that is two notches above South Africa across all three of the ratings agencies: S&P, Moody’s and Fitch.

According to a triennial report published by the Bank for International Settlements in April 2013, the peso was the 8th most traded currency in global markets. This ranks higher than the Chinese yuan and fellow BRICS counterparts’ the Brazilian real, Russian rubble, South African rand and Indian rupee, as well as the Turkish lira. Daily peso volumes of $135bn are $15bn more than the yuan and is more than the $59bn and $70bn of the South African rand and Turkish lira respectively, combined.

Rank

Currency

Nation / Region

Global Share

1

USD

USA

87.0%

2

EUR

Europe

33.4%

3

JPY

Japan

23.0%

4

GBP

Great Britain

11.8%

5

AUD

Australia

8.6%

6

CHF

Switzerland

5.2%

7

CAD

Canada

4.6%

8

MXN

Mexico

2.5%

9

CNY

China

2.2%

10

NZD

New Zealand

2.0%

12

RUB

Russia

1.6%

16

TRY

Turkey

1.3%

18

ZAR

South Africa

1.1%

20

INR

India

1.0%

(Bank for International Settlements)

Global share adds up to 200% based on the paired nature of any currency trade.

 

Interestingly, the only three emerging market currencies which trade on global markets 24 hours a day, five days a week, are the rand, lira and peso. This means that should Argentina report a negative outcome on their debt negotiations with certain US hedge funds on a Thursday evening after markets are closed, it will be the Mexican peso and not its Argentinean namesake which will be under pressure.

Fuelling the flame of the peso as the worlds emerging market currency Piñata is the fact that it is much cheaper to short the peso than it is the rand or lira, primarily due to interest rates in Mexico being lower than those in either South Africa or Turkey. The Mexican repo rate equivalent is at 3.75% against that of 7.50% in Turkey and 7.00% in South Africa; making a short peso position approximately half as expensive to execute. Worth noting is that higher inflation rates usually lead to higher interest rates which protects that country’s currency as hedging currency risk becomes more expensive.

In response to the market volatility, in mid-February, in a duel move announced by both the central bank Governor and Finance Minister, Mexico stated that it would remove the policy of predictable dollar auctions and rather begin selling greenbacks directly to banks at unannounced times and in undisclosed amounts. The rhetoric being: beware of using the peso as an EM proxy as there is a good chance that the central bank will be on the opposite side of the trade. In order to show speculators Mexico was truly serious central bank Governor Agustín Carstens unexpectedly raised the benchmark interest rate by 50bps to 3.75% in a move outside of a scheduled meeting for the first time in over 13 years.

Central bank currency protectionism via interest rate hikes and open foreign currency market operations can and have led to an appreciation in the Mexican peso, recovering some 5% since the announcement of these actions. What’s interesting to look at then is the monthly changes in foreign currency reserves held and compare this to recoveries in the value of the currency, displayed in the chart below. What’s clear is the correlation of reductions in reserves (buying back pesos) and an improvement in the value of the currency, especially in times of heightened volatility. This is also true for South Africa and the rand.

Rand USD 

Whilst it’s foolish to speculate whether an official policy of protectionism-based open market rand purchases by the SARB exists in South Africa, one cannot ignore the similarities in the movements of the currencies on the back of reductions in forex reserves. Whether or not the SARB has engaged in such actions will be somewhat muted by the fact that global players’ – from other central banks to multinational money managers – current market activity dwarfs that of emerging market central banks. What is certain is that the Mexican authorities have taken a firm stance on removing themselves as the world’s EM Piñata.*Mexico has had a long standing policy of utilising derivative markets to hedge out the risk of adverse oil price movements, with a price floor of $49/bbl secured for 2016. This reduces the risk of massive budgetary constraints in the wake of weak oil prices.