Mexican Peso recovers as risk appetite improves, carry-trade inflows still a supporting factor

• The Mexican Peso trades mildly higher as risk appetite improves on Thursday. 
• Disappointing Nvidia earnings had weighed on equity markets during the Asian session, but they are recovering. 
• Mexico's high interest rates still attract carry-trade inflows, despite the Peso weakening. 

The Mexican Peso (MXN) trades marginally higher in its key pairs on Thursday as market sentiment improves heading into the European session, benefiting the risk-on MXN. European equities are trading modestly higher after a shaky start as investors get over the bitter aftertaste of disappointing Nvidia earnings. 

The Mexican Peso is rising the most against the Euro (EUR) after the release of preliminary Spanish Consumer Price Index (CPI) data for August revealed a sharper-than-expected slowdown of inflation in Spain, one of the member states with higher levels of inflation in the Eurozone. Several key German states also published inflation data ahead of the release for the whole of Germany later today, signaling that price pressures are abating as well in the Eurozone's largest economy.

The data suggests the European Central Bank (ECB) is more likely to continue cutting interest rates, which is negative for the Euro as it would lower foreign capital inflows. 

At the time of writing, one US Dollar (USD) buys 19.59 Mexican Pesos, EUR/MXN trades at 21.73, and GBP/MXN at 25.84.

Mexican Peso upside limited by political risk

The Mexican Peso may see upside potential limited by political risk factors. The government's proposed reform to make judges and magistrates elected by popular vote  has been criticized as undermining justice, democracy and investor confidence in Mexico. 

Disagreement over the reforms has led to public demonstrations in Mexico City by members of the judiciary. The US ambassador to Mexico, Ken Salazar, said the "popular direct election of judges is a major risk to the functioning of Mexico's democracy."

The Mexican government chose to "pause" diplomatic relations with both the US and Canada on Tuesday due to disagreements over the reforms. If the stand-off escalates, there is a chance it could negatively impact free trade between the three countries, with negative implications for the Mexican Peso. 

At the same time, the Peso could benefit from an escalating trade war between North America and China. News on Tuesday revealed that Canada has decided to increase tariffs on Chinese electric vehicle (EV) and steel imports, by 100% and 25%, respectively. 

The decision could benefit Mexico, however, because of its existing role as an intermediary manufacturer for Chinese goods entering North America. 

Mexican Peso gains back wind from interest-rate differentials

The Peso is further supported by the high level of interest rates set by the Bank of Mexico (Banxico) at 10.75%, compared to counterparts. The interest-rate differential  has gained particular importance as expectations increase that the (US) Federal Reserve (Fed) will make deep cuts to interest rates in the US. 

According to data from the Chicago Board of Exchange (CBOT), for example, the market is pricing in 1.00% of cuts by the Fed before year-end. This would bring its key fed funds rate down from 5.25%-5.50% to 4.25%-4.50%, further widening the differential with Mexico. That said, the Banxico is also expected to cut interest rates, though according to advisory service Capital Economics, not as steeply as the Fed (0.50% by year-end instead of 1.00%). 

Overall, the differential continues to favor foreign capital inflows into the Peso, although the Peso's recent weakness has reduced the popularity of the MXN carry trade. 

Technical Analysis: USD/MXN 

USD/MXN is pulling back as it moves higher within a rising channel. It is in an established uptrend which given "the trend is your friend" favors longs over shorts. 

USD/MXN 4-hour Chart 

Of late the pair has pulled back down to support at circa 19.52 (August 22 high) and is churning in the 19.50s. Given the dominant uptrend, however, the odds favor an eventual recovery and resumption higher. 

A break above 19.80 would confirm more gains towards the upper channel line in the 20.60s.