Why The Mexican Central Bank's $1 Billion Intervention Failed: Goldman Explains

Tyler Durden's picture

Following the MXN rough start of the year, which saw the Mexican currency tumble to its lowest level ever, the central bank stepped into the FX market this morning by selling about $1 billion USD spot, hoping to break the destabilizing MXN relentless depreciation trend. According to the central bank market operations manager, the authorities are not just seeking to stabilize but to “strengthen the Peso”.

Putting the recent move in the peso in context, the MXN's Real Effective Exchange Rate (REER) has depreciated 41% since mid-2013 and is now at its weakest level in more than 20 years. In fact, the only time the REER was weaker than it is currently was in the aftermath of the ravaging 1994-1995 "Tequila" economic and banking crisis. That is, the current MXN weakness is unprecedented outside the grip of a major crisis and is also visibly weaker than the level reached during the 2008-09 GFC.

There is just one problem: so far they have failed dramatically, with the peso sliding ever since the intervention, and moments ago almost filling the entire gap.

To be sure, one can't really blame Banxico for intervening: with the local population, of which over half lives in poverty, angry and protesting the recent "Gasolinazo", or 20% increase in the price of gas, the crashing currency is sure to send many other prices, especially of imported goods, through the roof while sending much of the population over the edge. Which is why Goldman's Alberto Ramos agrees that the central bank had to do something:

"In our assessment, some FX market intervention at this juncture is justified since market liquidity conditions became somewhat tighter, the MXN entered overshooting territory (excessively undervalued) and from current levels, significant additional exchange rate weakness, while making exporters even more competitive, can threaten two valuable public goods: price and local financial market stability. A very weak currency can have significant medium-term costs for the broader economy as it is likely to add pressure on inflation and wages (which would over time reduce the cost-competitiveness of the Mexican exporters) and prompt to a tighter monetary stance. Overall, higher inflation/wages and higher rates would be a clear negative shock to the non-tradable sectors of the Mexican economy, for they would not enjoy the exporters (tradable sectors) benefit of a weak currency.

So much for a "brave new world" in which global trade imbalances can be resolved without central bank intervention. If anything, the events from the first 4 days of 2017, in which we first saw a dramatic indirect intervention by the PBOC which sent the overnight CNH deposit rate to the highest ever in a desperate attempt to crush shorts, and then the Mexican direct intervention, have confirmed that 2017 will be very much like 2016 when it comes to central bank intervention, if not more so.

However, as Goldman admits, Banxico made one mistake which explains why virtually the entire post-intervention move has been faded:

In our assessment, if the MXN remains under pressure the authorities should entertain the possibility of using different intervention instruments, such as USD Dollar swaps, for they are not a direct claim on reserves and offer valuable FX hedging protection to the market in a period of significant uncertainty but no large spot market outflows.

There is a problem with using reserves to fight a currency war, one which China is very familiar with:

On the other hand, using USD swaps is precisely what the PBOC shifted to late in 2015 (perhaps as advised by Goldman then too) when it too realized that using reserves was a very rudimentary (if effective) attempt at intervention. The only problem is that it eventually catched up to the central bank, and just like in the case of China which used swaps for about 3-4 months even as the capital outflows persisted, it ultimately had to return to draining reserves for a full blown intervention.

Ironically, even that has failed, and as we have documented extensively in the past 2 months, the PBOC is now scrambling with intraday gimmicks like crushing shorts using deposit rates. That too only works for a while.

Meanwhile, Mexico is caught between a rock and a hard place, because while the currency is depreciating, and the "MXN is now visibly undervalued versus theoretical fundamental fair-value under any of the three model metrics we use" Goldman warns that any further depreciation can undermine the inflation backdrop and/or risk unleashing destabilizing financial forces.

Which is all Trump needs: a several economic crisis just south of the border.

Actually, there is another thing Trump "needs": Mexico launching an all out currency war against the US, whether through reserve draining (which would hit US assets) or USD swaps. Should the central bank intervene on a few more occasions to offset today's failed revaluation attempt, which the market is now openly mocking, we eagerly await the barrage of tweets that will be launched by the Trump account as the president-elect, having slammed the occasional stock, shifts to FX.

Trump aside, what happens next? Once today's intervention fails, the Peso is looking at a lot more downside, and as Rabobank's Christina Lawrence writes,the MXN could fall as far as 23, as there "is little room for MXN relief as Banxico is highly unlikely to provide any lasting support for peso as market is too liquid and Mexico’s reserves will start to evaporate very quickly." Putting trading volumes in context, MXN is the 10th most liquid currency globally with an average daily volume in the spot market of $43b and $112b when including options.

Rabo says that it “expects volatility to rise further and for the skew to continue moving to the right as market participants move to protect themselves from further USD/MXN upside”

Finally, the real message here is that the Banxico’s intervention "may also be seen as sign of greater underlying problems." Bingo.

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evoila's picture

no, it's because you can't polish a turd.

Draybin Deffercon III's picture
Draybin Deffercon III (not verified) auricle Jan 5, 2017 1:28 PM

Zerohedge killed Bitcoin again! You bastards!

itstippy's picture

You jerk!  A week ago I sold all my stocks, gold, and firearms and purchased Bitcoin based on your recommendation.  Now I'm ruined.  

buzzsaw99's picture

lol @ mexico reserves

LawsofPhysics's picture

Let me be clear, the purchasing power of all fiat currencies is heading to zero...

..eventually.

Got ownership of productive capacity and a dependable tribe to defend it?

Rudolph Steiner's picture

Hugo Salinas Price and the new MXN Silver Peso for 2017?

That would put a cork in things... a silver cork.

Plata.com.mx

deer_flasher's picture

You'd be right rudolph, the silver peso would stop the bullying from the US and fire up the price of silver, unlikely our leaders will do that, but if done, it will save the economy and stun a few

Jay's picture

viva Mexico if that happens!

Bankers R Wankers's picture

It would be the best thing for "Mexicans" Too bad they are not in charge, the PRI/PAN aka Mexican Status quo is WAY bigger and more powerful than it is here in the US. So it will never happen. I am from Mexico, the peso is going to 25-30 because the moron in Los Pinos (Mexican White House) Is running the country all for his personal gain, soon there will be another mexican atop the Forbes list hiding lal the assets Pena Nieto stole. Slim is the cover for Salinas. 

Bankers R Wankers's picture

It would be the best thing for "Mexicans" Too bad they are not in charge, the PRI/PAN aka Mexican Status quo is WAY bigger and more powerful than it is here in the US. So it will never happen. I am from Mexico, the peso is going to 25-30 because the moron in Los Pinos (Mexican White House) Is running the country all for his personal gain, soon there will be another mexican atop the Forbes list hiding lal the assets Pena Nieto stole. Slim is the cover for Salinas. 

deer_flasher's picture

It happened before, and will happen again, the peso crashes every 25-30 years like clockwork, we have had it worse in the past, shit will hit the fan, another nasty devaluation, job loss and the likes, and then will be bussines as usual, whoever is president in the US. Trump will have mexas sent back here (we don't like those betrayers here either, they're not mexicans as far as we're concerned) and the economy will suffer of course. I'll help build the border wall if americans keep their guns on their crazy ass warzone country and stop using coke, if that happens, count on us to build the damn thing.

Money_for_Nothing's picture

I think Mexico needs a modern day Sam Houston to bring them into the 21st century. A long time ago Mexico was a first rate nation. Mexico is turning into the Indian Territories of the Old West. A good place for bad men to get wealthy.

deer_flasher's picture

He was called porfirio diaz (houston was good, but nothing compared to diaz), mexico was en route to becoming like france and many 1st world countries at the beginning of the 20th century, but then we had the revolution and it all wento to hell and never got better, back in the day the silver peso was the deal for sure

turkey george palmer's picture

The interventions fail and the dollar will soar. Short gold it's going to 900

Money_for_Nothing's picture

Bill Clinton pulled $50 billion out of a stash to prop up Mexico.
Obama will probably pull $500 billion out of somewhere to do the same.
History rhyming.

NAFTA turns US Presidents into magicians.

HRH Feant's picture
HRH Feant (not verified) Jan 5, 2017 1:55 PM

That chart looks like the Peso is being flushed.

Johnny Debt's picture

Bitcoin by $600 - Tomorrow

itstippy's picture

My Bitcoins!  WTF is going on?  The goddamn Russians and Chinese are up there in the Cloud somewhere fucking with my Bitcoins!