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business newsOptions Market Accepts Mexican Peso's Recovery
Not only has QE2 convinced the foreign exchange market that the peso has been preferable to the dollar, the options market is comfortable with further peso strength.
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The reception was chilly, to say the least; several listeners were adamant the MXN was going to devalue toward 13 within months of Fox taking the reins; this level was not reached until the 2008 financial crisis. Today the MXN is trading around 11.7 and getting stronger.
Whenever the question arises as to my opinion on “the dollar,” I am careful to distinguish between the euro-dominated dollar index and various other currencies not in the index but important to US trade flows and, yes, cross-border movements of labor. Mexico’s two largest sources of foreign exchange are crude oil and remittances from Mexicans living and working elsewhere, primarily in the US.
Here Mexico faces two different problems. First, while the price of crude oil clearly increased between 2004 and 2010, Mexico’s average daily production declined 23.9%, from 3.383 million barrels per day to 2.575 MMB/D. Mexico’s largest field, Cantarell, is in a massive and irreversible decline. Second, remittances depend on the labor market in the US, and the outlook for Mexicans living in the US is no better than it is for Americans living in the US. A modest improvement in the US labor market led to a 5.5% increase in remittances in the first quarter of 2011 compared to 2010 levels, but this has been more than offset by a 10.8% increase in the peso relative to the dollar since QE2 began.
That the peso has the dollar on the run since Ben Bernanke & Company restarted the printing press is more than embarrassing. Let’s compare the official loss of purchasing power in the two currencies since the start of the floating exchange-rate era in 1973. The dollar has lost 80.97% of its purchasing power; the peso 99.98% of its purchasing power. I emphasize: These losses of purchasing power are based on official CPI readings; you are free to decide for yourself whether these are accurate assessments.
Not only has QE2 convinced the foreign exchange market that the peso has been preferable to the dollar, the options market is comfortable with further peso strength. If we map the three-month volatility of MXN forwards against the MXN itself and note with a green line Bernanke’s Jackson Hole speech, we see volatility has declined as the peso has increased. This condition would have struck my Mexican audience as preposterous or even worse 11 years ago.
Peso strength may be of greater interest to currency traders than to stock investors. The iShares Mexico ETF (EWW) has gained 26.81% since Jackson Hole; this is actually less than the 27.98% gain seen for the iShares Russell 3000 ETF (IWV). Such an inverse relationship between currency strength and relative equity performance has not been unusual in a world where everyone thinks they can achieve prosperity via monetary debasement.
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