The strength of the Mexican Peso (MXN) is determined by a complicated mix of factors. Other important factors are the strength of the Mexican economy, the actions of its central bank, and external factors such as foreign direct investment and remittances. The strength of the MXN varies greatly depending on positive/negative economic indicators and the mood of the global market. This is what makes it such an indispensable currency amongst the emerging markets.
The Mexican economy has experienced several periods of rapid growth. Second, its performance is a key determinant of the likely future value of the MXN. When economic indicators point to strong growth, low unemployment and high consumer confidence, the peso tends to get stronger. Mexico’s central bank, Banxico, plays a vital role when it comes to making tough decisions. All of these decisions affect our proverbial money in a profound and deep way.
Key Influencers Behind the MXN Value
One of the biggest drivers of the MXN’s strength is the overall health of the Mexican economy. A booming economy means booming domestic consumption, but means we’re more attractive to foreign investment. When investors see opportunities to make money in Mexico, it makes them want to hold MXN, increasing demand for the currency. This dramatic increase in capital inflow quickly plays out positively on the currency’s exchange value.
Mexican expatriates, particularly those residing in the US, remit large amounts of money to Mexico. This continuous inflow of capital has been extremely important in boosting the value of the MXN. These remittances have become an important, stable source of income for millions of Mexican households and play a key role in supporting domestic consumption. More globally, the predictable stream of remittances helps stabilize an economy battered by shocks and provide confidence in the peso.
The second most important underlying driver of the peso is the monetary policy pursued by Banxico. When inflation rates rise above target levels, Banxico’s established response has been to raise interest rates in order to rein in inflationary pressures. These rate hikes constrain the economy by increasing borrowing costs for households and businesses alike. That’s likely to have a dampening effect on overall demand in the economy.
The Relationship Between Interest Rates and Currency Value
The connection between interest rates and value of a currency is a complicated phenomenon. This tends to pull foreign investment, as investors seek higher yields, making a country with higher interest rates like Mexico a more attractive destination for capital. For example, as there is increased demand for the MXN – in part because of foreign capital inflows – its value appreciates.
At the same time, higher interest rates have a negative impact on domestic demand. As borrowing becomes more costly, so does the potential for consumer and business spending growth. All of this would likely have a recessionary effect in the near term by reducing the pace of economic expansion. A positive economic context would give Banxico more leeway to keep interest rates stable or even increase them. Even amidst the risk, this decision would make the peso more attractive to investors.
That’s because the MXN tends to appreciate whenever investors are in a “risk-on” mood. At these moments, they are more willing to bet on developing frontier markets. In times of market tranquility, the peso would likely appreciate. Continued capital flight can occur as foreign direct investment, especially from investors seeking higher returns in riskier markets. Second, as an emerging-market currency, the MXN’s performance is largely driven by global economic trends and sentiments toward risk.
The Competitive Edge of the Mexican Peso
Of all its Latin American neighbors, the Mexican Peso is by far the most active trading currency. This exceptional level of trading activity is indicative of the high level of investor confidence as well as Mexico’s strategic position within global markets. Combined with its impressive liquidity, the peso is an appealing choice for anyone seeking exposure to emerging markets.
In a booming economy, a stable MXN can help to attract other investors to join the party. Under just the right combination of conditions, the peso does well.
Positive drivers of exchange rate appreciation include high economic growth, low unemployment and strong foreign investment. This dynamic establishes a positive feedback loop: a strong peso attracts more investment, which encourages further economic growth.
In response to rising inflation, Banxico is increasing interest rates to ensure price stability and reinforce economic activity. Consequently, the increased yields from these rates are producing more alluring Mexican investments compared to U.S. Moreover, investors are concerned with sourcing opportunities where there is the potential for capital appreciation while providing strong competitive returns on yield.