(Bloomberg) -- Mexico’s peso is taking the brunt of an unwinding in carry trade positions in Latin America, slumping to the lowest in almost two years on Monday and leading losses among its regional peers.
The currency dropped as much as 5.4% — more than its annual move in six of the last seven years — before rebounding to trade little changed and then dipping again. For a few minutes it fell below 20 pesos to the dollar for the first time since October 2022.
Monday’s slump made the Mexican currency the biggest decliner in emerging markets over the past month, dropping 6.6%, buffeted by a series of global headwinds. A surprise jump in US unemployment reported on Friday fueled concern over a hard landing in the economy Mexico depends on for the vast majority of its trade. At the same time, a rally in the yen, a funding currency for carry trades, has led to the violent unwinding of long positions in the Latin American currency.
“The impact on the Mexican peso has been disproportionately large,” said Deutsche Bank economist Francisco Campos. “It’s a double-whammy effect in a context where it was already facing idiosyncratic challenges.”
Investors started to unwind carry trades — in which they borrow in a low-yielding currency and bet on one with higher interest rates — as Japanese authorities intervened in the currency market to push up the yen. Then monetary authorities surprised most economists by raising interest rates last week for the first time since 2007.
The currency rallied as much as 3.4% Monday on concern over a US recession.
But it’s not just international factors that threaten the Mexican peso.
“I worry about Mexican politics coming back into play when the new parliament sits in September — and that might prevent the peso from straying too far below 19.00 now,” said Chris Turner, head of foreign-exchange strategy at ING.
Volatility spiked in the peso earlier this year when the ruling party obtained a near supermajority in congress in elections, raising the possibility of radical policy shifts. A major concern is whether incoming President Claudia Sheinbaum will try to reform the constitution.
The worries come after the Mexican peso strengthened 5% in 2022 and 13% last year, hitting a nine-year high in April.
President Andres Manuel Lopez Obrador has taken pride in the strength of the peso over the period of his mandate. Now, he weighed in to limit the selloff, saying the country’s international reserves, currently at a record high, will help it withstand the depreciation.
While the peso lacks positive drivers in the near term, the room for additional losses may be limited considering part of the carry-trade dismantling is likely already behind it, according to Brad Bechtel, global head of foreign exchange at Jefferies in New York.
“It’s always hard to tell in these big unwindings, but I would think we are closer to the finish line,” Bechtel said.
--With assistance from Michael O'Boyle.
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