Mexico’s peso sank after the central bank said it will reduce a hedge program designed to tame volatility, signaling to traders the rally that made the currency the world’s top performer may have gone too far.
The program, created in 2017 just as Donald Trump came into office in the US and boosted in 2020 during the pandemic, will be gradually reduced starting in September, according to a Thursday statement from Banxico, as the central bank is known. Banxico has around $7.5 billion of outstanding positions in these instruments.
Operating conditions in the exchange market “have returned to adequate levels” of liquidity and depth, Banxico said in the statement. “Credit institutions and other economic agents have the conditions to cover their risks related to the exchange rate directly in the exchange market.”
The shift is “a clear sign that the peso might be too strong,” said Benito Berber, chief economist for the Americas at Natixis.
Hedges will be rolled over once and for 50% of the current amount starting next month. For six-month operations, the term will be reduced to one month with the renewal only applying to 50% of amount. Operations with nine and 12-month terms will be left to expire.
Reducing the hedge program has “a lot of sense” given the current appreciation of the peso and Banxico’s hawkish monetary policy with record-high interest rates, said Felipe Hernandez, who covers Mexico for Bloomberg Economics.
“By reducing the stock of forwards outstanding policymakers recover exchange rate flexibility, opens room to intervene in the future if necessary,” he said. “It makes sense to do this while the peso is strong.”
Read More: Schedule of Banxico’s Outstanding FX Hedge Program
The Mexican peso sank on the news as traders digested the scaling back of the program, falling more than 1.7% to lead losses among emerging markets. While the currency was headed for its worst day since March, it’s still the the best performing major this year, up almost 15%.
“They are basically using the MXN strength as an opportunity to unwind these outstanding forward positions,” said Clyde Wardle, an FX strategist at HSBC Securities USA Inc.
--With assistance from Davison Santana.
(Updates with prices)