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Is the Magic Running Out of Weight?

05 August 2019

The intensification of the trade war between Trump and China has accentuated risk aversion in financial markets.

After the Fed disappointed with a split decision to cut rates last week, comes China's response to Trump's announcement of new tariffs: devaluation of the yuan and suspension of purchases of agricultural products from the US.

The dollar falls against the euro and the yen, but strengthens against emerging market currencies, including Latinos. Weight is no longer the exception.

After a stellar performance in 2019 as one of the strongest currencies, the Mexican currency fails to maintain strength in this new episode of market risk off.

The question is, why is the peso affected by a greater perception of risk towards China if Mexican exports to that nation are not very relevant?

It is understood in the case of other Latin economies more dependent on the prices of raw materials, but the Mexican economy depends mainly on manufacturing exports to the United States.

Five factors seem to explain the peso's decline:

1.- The probabilities of a slowdown / recession in the US economy, derived from a greater impact on investment due to the uncertainty caused by the trade war, increase.

2.- The prospect of weakness in the Mexican economy threatens fiscal strength. A semi-recessive scenario will eventually affect tax revenues.

3.- The risk Mexico begins to reflect the concern about the direction of public policies and its impact on the credit rating.

4.- The rate futures market anticipates that Banxico will cut 50 basis points this year, in response to lower inflationary pressures, less dynamism and greater slack in the economy.

5.- Foreign capital loses interest on the debt in pesos. From February 8 to July 25, foreign holdings of government bonds in pesos fell by 173 billion pesos.

The combination of stagnation / recession coupled with exchange rate stability was not sustainable.
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