Mexican central banker lists multiple risks for the peso

As factors continue to mount, Mexico's peso is depreciating even faster than it did in 2014 and volatility could well worsen moving forward, according to central bank deputy governor Miguel Sánchez.

Speaking at an event in Texas last week, Sánchez outlined four issues that have driven the peso to historically low levels, closing Monday at 19.678 pesos to the US dollar, as concerns grow that the dollar will break the psychological 20-peso barrier in the coming days.

"The Mexican peso has depreciated significantly since 2014. However, during the present year, the weakening of the currency has been more substantial than in other emerging economies. In addition to fears surrounding US hikes, other aspects more specific to Mexico seem to be at play," said Sánchez.

Various reports in the press are noting nerves surrounding Wednesday's monetary policy announcement from the US, worrying that there could be a rate hike. Others note that Japan's central bank also meets this week and are speculating on how it could affect the situation.

Sánchez, however, offered broader context, "In addition to fears surrounding US [Federal Reserve] hikes, other aspects more specific to Mexico seem to be at play" - the most important being Mexico's "weak fiscal position."

He highlighted the government's growing borrowing needs as a proportion of GDP, expected to rise to about 50% in 2016. Low oil prices are also hitting Pemex, the primary source of tax revenue in Mexico, which is reflected in the growing current account deficit.

The government's 2017 budget package now being considered by congress includes 239.7bn pesos (US$12.27bn) in cuts to hopefully produce a primary balance for the first time in several years and turn around the country's public deficit situation, a position drawing skepticism from some observers.

A weaker peso will make that task more difficult, particularly in terms of interest payments.

Another factor is related to disappointing results in the markets. The lack of pass-through of recent structural reforms into growth in investment in Mexico influenced S&P's decision to change its outlook on the sovereign debt to negative in August.

A third factor, he said, was the tight US presidential race and concerns over a Donald Trump win, a factor that has received much attention in the last week with the incendiary Republican candidate pulling ahead in some polls.

Finally, he expressed concern that the currency swings could be exacerbated by "the fact that derivatives are used to hedge peso positions and as a proxy for other emerging‐market asset investments."

Volatility could easily increase in the future, in light of so many unknown global geopolitical and financial variables" made worse by "high exposure to foreign holdings of peso-dominated government debt."

However, The most worrisome aspect for Sánchez is the potential upside risk to inflation by depreciation.

"The possibility of higher contagion from Mexican peso weakening ... could generate deviation of inflation and expectations from the target. Sudden increases in pass‐through cannot be ruled out," he said.