USD/MXN Remains Bid as Delta Variant Risks Brew

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MEXICAN PESO KEY POINTS:

  • The Mexican peso fails to recover against the U.S. dollar despite risk-on mood, as emerging markets remain vulnerable to the delta variant of the Covid-19 virus
  • Near-term USD/MXN volatility could increase significantly if negative COVID-19 stories begins to dominate the news cycle
  • However, once market anxiety begins to dissipate, the economic recovery narrative could regain traction, boosting EMFX

Most read: Wall of Worry Builds as Financial Markets Focus on Delta Variant – Market Minutes

The Mexican peso fails to recover and weakens 0.2% to 20.12 per dollar on Tuesday, following a sharp sell-off in the previous session. As a reminder, the USD/MXN exchange rate soared 0.8% on widespread risk aversion and a sharp drop in oil prices on Monday, induced by concerns that global expansion will weaken in the face of rising cases of delta-variant coronavirus around the world. Investors fear that the more transmissible mutation of the virus will lead governments to reimpose mobility restrictions, denting the pace of recovery.

Generally speaking, EMFX needs a healthy and stable economic backdrop to perform well against the greenback. Any sign of weakening growth or challenges ahead can hurt risk sentiment and drive demand for defensive positions.

All things considered, headwinds appear to be developing for the EMFX complex in the near term. In the coming weeks, as Covid-19 delta strain infections increase, pandemic-related headlines are likely to dominate media coverage, unnerving investors. This may trigger strong volatility and sporadic bouts of MXN selling. In fact, one-month implied volatility for USD/MXN hit 11.5% today, a four-week high, a sign that price action may be poised for a big move soon.

It remains to be seen whether the delta variant will derail the global recovery, but the data so far suggest that the more contagious strain of the virus may not pose a long-term risk to markets. In support of this argument, it is important to note that in several countries with high inoculation rates, such as the United Kingdom and Portugal, the new wave of the virus has not led to an increase in hospitalizations or fatalities as in previous outbreaks.

Given that Western vaccines effectively prevent bad outcomes and significantly decrease mortality, it is unlikely that blanket lockdowns will materialize again. That said, once exaggerated anxiety dissipates and delta-variant fears subside, the recovery narrative should regain traction, providing a boost to emerging market currencies, especially those with an attractive carry.

USD/MXN TECHNICAL ANALYSIS

From a technical perspective, despite the large rally on Monday , USD/MXN remains stuck between horizontal resistance at 20.20 and trendline support near 19.85. For price to gain short-term directional conviction and a distinctive bias, the pair must break decisively either of those levels. Having said that, if resistance is overcome, USD/MXN will have fewer technical obstacles to climb towards the 20.75 zone, where the June high converges with an impeccable 13-month descending trendline.

On the flip side, if the exchange sinks below support at 19.85, sellers could prompt a larger sell-off and push price towards the 2021 low in the 19.55 area. If this support fails to hold, the 19.00 psychological level will come into play.

USD/MXN TECHNICAL CHART

Source: TradingView

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—Written by Diego Colman, DailyFX Market Strategist

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