Mexican Peso extends rally unfazed by economic contraction

• The Mexican Peso strengthened for the third straight day despite Mexico's Q4 GDP contraction.
• Banxico is expected to cut rates to stimulate the economic recovery amid global uncertainties.
• Monetary policy divergence between Fed and Banxico, plus US tariff threats, to boost USD/MXN.

The Mexican Peso (MXN) surged for the third consecutive day against the Greenback as the emerging market currency shrugged off Mexico's economic contraction in Q4 2024, according to the Instituto Nacional de Estadistica Geografia e Informatica (INEGI). Weak growth figures in the United States (US) lent a lifeline to the Peso, as seen by the USD/MXN pair, trading at 20.41, down 0.42%.

The Gross Domestic Product (GDP) in Mexico contracted quarterly, justifying the latest actions taken by the Banco de Mexico (Banxico), which lowered rates by 25 basis points (bps) at the December meeting.

Although it would be tempting for Banxico to increase the size of the easing from 25 to 50 bps, potential US tariffs imposed on Mexico and Canada could impact the economy, exerting pressure on the Mexican Peso.

Across the north of the border, the US GDP for the fourth quarter missed forecasts, while the number of Americans filling for unemployment claims hinted the labor market remains solid, according to the US Department of Labor.

Given the backdrop, the USD/MXN pair extended its losses beneath the crucial 20.50 figure. However, the central bank divergence between the Federal Reserve (Fed) and Banxico suggests the exotic pair is poised for higher prices.

Toward the end of the week, the US economic docket will feature the release of the Fed's favorite inflation gauge, the Personal Consumption Expenditures (PCE) Price Index, and Fed speakers. Regarding Mexico, the schedule is empty, but traders will await the release of Foreign Reserves on February 3.

Daily digest market movers: Mexico's economic slowdown to weigh on Mexican Peso

• INEGI announced that  Q4 2024 GDP shrank by -0.6% QoQ, more than the -0.2% contraction expected by economists and down from Q3 1.1% expansion. On a yearly comparison, GDP rose 0.6%, beneath forecasts for a 1.2% growth rate, its lowest rate since Q1 2021.
• The data supports Banxico's dovish stance. The Mexican institution is expected to lower rates at least by 25 bps from 10% to 9.75%, though analysts from Capital Economics suggest that 50 bps of easing are on the table.
• Banxico Deputy Governor Omar Mejia Castelazo was dovish on Wednesday and said that Banxico has enough room to maneuver and calibrate monetary policy at upcoming monetary policy meetings.
• The US Department of Commerce revealed that Q4 GDP dipped from 3.1% to 2.3%, missing investors' estimates of 2.6%.
• Meanwhile, the US Department of Labor revealed that Initial Jobless Claims for the week ending January 24 increased by 207K, beneath forecasts of 220K and the previous week 223K.
• On Wednesday, the Fed kept rates unchanged at 4.25% - 4.50% on a unanimous vote, justifying their decision due to the strength of the US economy, the lack of progress on lowering inflation, and a recovery of the jobs market.
• Fed Chair Jerome Powell said the US central bank is in no rush to ease policy, reassuring that they don't have a pre-set path regarding monetary policy.
• Money market futures have priced in 50 bps of Fed rate cuts in 2025, according to CME FedWatch Tool data.

USD/MXN technical outlook: Mexican Peso appreciates but is still poised to weaken to 20.50

The USD/MXN uptrend remains intact, although sellers pushed prices toward the 50-day Simple Moving Average at 20.39 but could not crack that area, opening the door for a recovery.

Although momentum shifted bearish, as depicted by the Relative Strength Index (RSI), bears need to clear the 50-day SMA and the January 24 swing low of 20.12. A breach of the latter could send the USD/MXN tumbling towards 20.00 and below.

Conversely, bulls seeking a recovery need to lift the exchange rate above 20.50 and challenge the January 29 high at 20.66, forming a 'bullish engulfing' chart pattern.

In that outcome, the USD/MXN's next resistance would be the year-to-date (YTD) high of 20.90, which is ahead of 21.00.