As has been widely documented, the iShares MSCI Mexico Capped ETF (NYSEArca: EWW) has been under significant pressure following Donald Trump’s victory in the U.S. presidential election last month.
EWW, the largest ETF tracking stocks in Latin America’s second-largest economy, has plunged since Election Day as investors have fretted that Trump will move forward with plans to build a wall around the U.S./Mexico border while possibly looking to unwind the North American Free Trade Agreement (NAFTA).
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Investors mulling positions in EWW should be mindful of Mexico’s central bank and its plans for interest rates.
Although Mexico’s central bank said the first rate hike earlier this year was not the start of a new tightening cycle, the central bank surprised global investors Thursday when it boosted borrowing costs by 50 basis points to 4.75%, which is good for the country’s highest interest rate since 2009.
Throw the notion of Mexico not being in tightening cycle out the window as the central bank surprised market observers with another rate hike of 50 basis points last week in a bid to shore up the peso, which has sagged since U.S. Election Day.
“This is more aggressive than most people were expecting. The central bank is waging an unofficial battle to try to support the currency. They’ve been one of the most aggressive central banks in terms of hiking, even at a time when inflation has been below their official target. That’s partly because of a hangover of the Tequila Crisis when a depreciating currency presaged an economic crisis. Times have changed but a depreciating currency brings back bad memories in the minds of many Mexicans,” according to an Aberdeen note posted by Dimitra DeFotis of Barron’s.
Investors who believe the Mexican peso may continue to depreciate but anticipate the markets will improve can look to currency-hedged ETF strategies to diminish the currency risks. For instance, the db X-trackers MSCI Mexico Hedged Equity Fund (NYSEArca: DBMX) and the recently launched iShares Currency Hedged MSCI Mexico (NYSEArca: HEWW) provide exposure to the Mexico’s market without the added currency risk of a depreciating peso currency.
There is a chance the pace of rate hikes south of the border slows in 2017.
“Accordingly, there’s nothing here to suggest that Mexico’s central bank is thinking about slowing the pace of tightening. Our forecast is for interest rates to be increased by a further 100bp to 6.75% by end-17, which is above what is priced into the market (6.50%) and expected the consensus (just 6.00%),” according to a Capital Economics note seen in Barron’s.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.