Mexican Peso Gains as Powell Cautions Against a Hasty Move, USD/MXN Tumbles

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KEY POINTS MEXICAN PESO:

  • Mexican peso strengthens after Fed chairman Powell says the US economy has not progressed enough to start dialing back stimulus and warns against acting prematurely
  • USD/MXN pivots lower and retraces most of the previous day’s rally
  • The outlook for the Mexican peso remains constructive over the medium term, supported by its attractive carry and improving fundamentals

Most read: DXY Hits Important Area of Resistance. What’s the US Dollar Technical Outlook?

Yesterday, following a sharp rise in USD/MXN (U.S. dollar – Mexican peso), I made the case that traders could fade the rally in the near term if the Federal Reserve clung to the transitory inflation thesis and embraced with conviction its accommodative monetary policy stance. This appears to be the case on Wednesday, with the exchange rate retracing most of Tuesday’s gains and falling 0.9% to 19.86 at the time of this writing.

The dollar’s weakness and broad-based EMFX’s strength on display today was triggered by Fed Chairman Powell’s congressional testimony, in which he warned against acting prematurely and assured lawmakers that inflation is temporary and that “substantial further progress” in the economy is still a ways off. Those remarks have blunted expectations that the central bank would soon move to taper bond purchases, pushing down treasury rates across different maturities.

As I have argued several times in recent weeks, despite intermittent market noise, high-yielding emerging currencies maintain a positive outlook against the greenback, especially those with high-carry adjusted for volatility. While there are near-term risks, such as cooling global growth and rising delta-variant Covid-19 cases, yield differentials in a liquidity-flooded world and the Fed’s dovish bias regarding its quantitative easing program should be viewed as supportive variables (for EMFX).

As for the Mexican peso in particular, Banxico’s tightening cycle in response to mounting inflationary pressures, the improved economic backdrop in Mexico aided by strong external demand and rising oil prices can be considered bullish drivers. All these factors create a favorable environment for the MXN over the medium term.

From a technical perspective, USD/MXN price action remains stuck in a consolidation phase, compressed between resistance (20.20) and support (19.80). For the pair to gain directional conviction, either of these levels would need to be broken decisively. That said, if resistance is overcome, USD/MXN could drift towards the 20.75 area, where the June high aligns with a long-term descending trendline in play since June 2020. On the other hand, if price sinks below 19.80, selling pressure could gain momentum and trigger a move towards the 2021 low near 19.55. Should this support fail, the 19.00 psychological level would come in focus.

USD/MXN TECHNICAL CHART

EDUCATION TOOLS FOR TRADERS

—Written by Diego Colman, DailyFX Market Strategist

Follow me on Twitter: @DColmanFX

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