- We have been bearish on the MXN since May 2024, as global trade noise, a less appealing carry, a higher risk premium and a weak Mexican cycle pointed to a weaker currency. While our view materialised in 2H24, the MXN recovered in 2Q25 to levels well below 19.0. Most of the factors behind our negative MXN view hold; however, and we think it is essential to understand the broader USDMXN framework, from market risk sentiment to carry and fundamentals. In this note, we break down the factors shaping both short- and long-term dynamics in order to assess different scenarios and reference levels for the rest of the year.
- The long-term approach. According to the Purchasing Power Parity theory, the MXN remains undervalued. However, if we consider a behavioural equilibrium exchange-rate framework, with factors in addition to real rate differentials, such as external and fiscal balances, as well as relative productivity, the MXN is slightly overvalued.
- The short-term approach. We extended our analysis to examine the role of short-term market dynamics by building a high-frequency econometric estimation using daily data to assess the behaviour of the nominal USDMXN. This model incorporates key financial variables that track broad USD strength, sovereign risk, monetary policy expectations, global risk sentiment, rate differentials and political regime effects during the Trump administration. We also incorporated the S&P, though it is important to mention that the MXN-equities correlation shifts depending on the market driver (i.e., economic cycle or risk sentiment, which do not always move in the same direction).
- From a short-term market dynamics perspective, a weakening DXY is strongly associated with short-term MXN appreciation, and this effect amplifies in periods of lower global volatility. This dynamic suggests that a rebound in the USD, especially in a risk-off context, could put renewed pressure on the MXN. This does not mean that carry does not matter. As we have mentioned in recent notes, the MXN does respond to changes in the interest rate spread, but particularly in implied rates, as the appreciation has taken place without flows to local assets. But in this note, we argue that carry does not entirely explain USDMXN performance, and the recent movement has been more a function of a global negative sentiment towards the USD.
- Since most of the recent dynamics are explained by the DXY and global risk sentiment, we need to consider the possibility of the USD continuing its depreciation trend, particularly since it is still overvalued against most currencies. Still, the MXN has actually outperformed most of its LatAm and EM peers for the last three years in real terms and, as mentioned in the PPP, the relative appeal of the MXN is much lower than that of other currencies.
- In summary, the recent MXN strength appears increasingly disconnected from underlying macroeconomic fundamentals. The combination of an overvalued nominal exchange rate, excessive reliance on favourable global sentiment, and limited domestic catalysts suggests that the currency’s current level may not be sustainable. As such, we maintain a cautious outlook and continue to expect the MXN to weaken towards year-end, particularly if external conditions become less supportive – whether via changes in US yields, renewed volatility, or a moderation in global risk appetite.