Mexico 8217 s peso runs on auto mode

How far can the Mexican currency appreciate as traders await Mexico’s energy law to be enacted? Earlier this month, Mexico’s Senate approved the first of four energy bylaws for contracts to enable private companies to explore oil and gas. These policies had been a key element in boosting the Mexican peso in the first half of the year.

From oil to autos

Yet, there may be more promising currents for the peso other than the energy sector. Mexico’s automobile production in the first half of 2014, reached 1.6mln, narrowly exceeding Brazil’s. Analysts expect Mexico to secure its position as the new leader in Latin American car production throughout 2014. Soaring car export sales to North America are expected to make Mexico as the biggest source of US car imports by end of 2015.Daimler and Nissan have announced a €1bln factory in Mexico and so has BMW. With 80% of locally produced cars destined for abroad, Mexico’s auto exports are also set to overtake those in Brazil.

Mexico’s unemployment dropped over the last two months, reaching 4.8% in July, while manufacturing production rose 3.6% in the year ending in May. Q1 GDP rose 1.8% y/y, breaking out of last year’s 0.7%-1.6% range. 2014 GDP growth is estimated at 2.3% to 3.3%.

Peso to gain on Banxico’s pause

Earlier this month, Mexico’s central bank, Banxico, held the reference overnight rate at a record low of 3%. The last rate cut was a surprise 50-basis-point reduction in June, following a 25-basis point cut in October 2013 and a 50-basis point cut seven months prior, when the easing campaign got underway. Friday’s release of the minutes from this month’s monetary policy meeting will clarify the extent to which the doves continue to assert their bias over future policy. The decision to hold rates unchanged emerged after inflation rose 3.8% y/y in June, testing Banxico’s 3% target. Markets expect the central bank to shift towards “pause” mode, until rates are probably raised in H2 2015.

The Mexican peso lagged its Brazilian and Colombian counterparts so far this year, but continues to gain ground versus the USD, rising about 5% over the last six months. Banxico will closely monitor US growth and import demand once the Fed’s monthly asset purchases are concluded in autumn, which will help determine the central bank’s consolidation into neutral policy. For USDMXN, we anticipate additional (but gradual) retreat towards an initial target of 12.60. Any additional USD selling is likely to encounter stabilisation near the 100-WMA of 12.30. More interestingly, we expect EURMXN to extend this year’s decline towards 16.60 as the ECB’s insistence to ease contrasts with Banxico’s policy normalisation.