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Analysis: Mexico peso rise tests central bank's hands-off stance

Bank of Mexico Governor Agustin Carstens gestures during an interview in Mexico City September 13, 2012. REUTERS/Edgard Garrido
Bank of Mexico Governor Agustin Carstens gestures during an interview in Mexico City September 13, 2012. REUTERS/Edgard Garrido

By Jean Arce and Krista Hughes

MEXICO CITY (Reuters) - Mexico's peso is scaling new highs amid confidence in the country's reform push, a likely credit ratings upgrade and profit taking after last week's interest rate cut, sparking speculation about how far it will rise before authorities act.

The peso has gained 2.6 percent since the start of the month, the best performance of the 152 currencies tracked by Thomson Reuters, and broken through key levels of 12.50 per dollar for the first time in 18 months.

The rise has come despite a 50 basis point cut in benchmark interest rates to a record low 4 percent on Friday, which only served to fuel investor optimism about the outlook for Latin America's No. 2 economy.

A signal from ratings agency Standard and Poor's that it might upgrade Mexico's credit rating and the announcement of plans to introduce more competition into the communications sector have also boosted Mexico's standing.

"As an investor, this is positive ... and will attract more capital to Mexico," said Rudy Amoresano, founder of boutique fund manager Caerus Management, of the reform plan.

More capital is the last thing the central bank wants. The Banco de Mexico warned that heavy inflows could lead to an 'unnecessary' tightening in monetary conditions, as a stronger peso would drag on growth.

"The market is testing to see how far the central bank will allow the peso to appreciate without taking any kind of action," said Enrique Alvarez, Latin America strategist at IDEAglobal.

Even though the rate cut has not dissuaded investors in the short term, the famously non-interventionist Banco de Mexico has more options up its sleeve.

It could officially drop a mechanism triggering an automatic offer of dollars if the peso weakens sharply, introduced when the currency was going through a weak patch in late 2011.

Banorte-Ixe economist Gabriel Casillas said this could be a first step, possibly followed by reinstating a monthly auction of dollar "put" options. This would build up Mexico's foreign reserves cushion and also pour pesos into the market, helping to curb gains. The central bank did this in 2010 and 2011.

"It's an ingenious thing where actually the market intervenes and the central bank does not," said CIBC World Markets Latin America strategist John Welch.

Under the program, the Banco de Mexico auctions the right to sell dollars back to the central bank. If the peso appreciates strongly, a bank may exercise its option and it will get more pesos for its dollars than it would on the floating peso market.

SPECULATION COOLS

Welch said some of the recent peso gains could also be explained by an unwinding of hedge positions put on by investors during a recent rally in Mexican bonds before the rate cut.

"A lot of people hedge their rate exposure and their bond exposure by shorting the peso and buying dollars, so once they got the fact of the cut, many of them took profits and they would unwind the hedge, which is they would sell dollar-MX instead of buying it," he said.

One welcome sign for the central bank, which has publicly sworn off any involvement in the 'currency wars' of competitive devaluations, is that speculators are backing off from record bets on further peso appreciation.

Speculative net long positions are down more than 35 percent from mid-January, when the peso reached a 10-month high and the central bank first warned of lower rates ahead, according to data from the U.S. Commodity Futures Trading Commission.

Net bets on a stronger peso were the weakest in three months for the week of March 5. The current week's data, due for release on Friday, will show if that trend has accelerated.

But Bank of America Latin America strategist Ezequiel Aguirre said the reduction in the positions was a signal for some traders to get back in.

"The position was cleaned out, so now you have a lot of investors getting together to push the peso," he said.

Another way to dampen upward pressure on the peso would be to give incentives to accelerate capital outflows, perhaps via Mexican pension funds, or Afores, which hold 1.9 trillion pesos ($153.51 billion) in assets.

Peru has raised the foreign investment limit for its pension funds to help stem currency appreciation, although Mexico's funds do not even hold the maximum in offshore assets allowed.

Data from regulator CONSAR show the funds hold 15.7 percent of their assets offshore, below the 20 percent limit, but up from the 11.9 percent they invested two years ago.

Barclays Capital economist Marco Oviedo said one reason the peso was not already at the 10.5 per dollar levels seen before the financial crisis was private capital outflows by Mexican residents, including the Afores.

Although foreigners pumped a record $80 billion into Mexican stocks and bonds last year, Mexicans sent $7 billion out of the country to invest in markets overseas, and another $26 billion in direct investments - double the level of 2011.

But if Mexico gains momentum on reforms, passing the telco changes and pushing ahead with proposals to shake up the tax system and energy sector, foreign capital inflows could push the peso to 12.20 by October, Oviedo said. ($1 = 12.3982 Mexican pesos)

(Additional reporting by Alexandra Alper; Editing by Eric Walsh)

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