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CURRENCY ANALYSIS

JPY/MXN: Reflections

JPY, MXN, Reflections, Bank of Mexico, Governor, Agustin Carstens, Bank of Japan, Haruhiko Kuroda, BOJ, BOM, Currency Analysis, fx trader, forex

9 Mar 2016

Bank of Mexico Governor Agustin Carstens and Bank of Japan Governor Haruhiko Kuroda are not only half a world apart geographically, but each is half a world apart on inflation. Governor Carstens has been doing his utmost trying to arrest Peso inflation. Conversely, Governor Kuroda has been doing his utmost trying to arrest Yen deflation. 

Both the BOM and BOJ are both sensitive to global superpower-economy-primary-trade-partners. Mexico may still be considered an emerging market. However, it has the advantage of the North American Free Trade Agreement (NAFTA) in which it conducts 70% of its trade with the United States. To a certain extent, a weak Peso may be an advantage to Mexico particularly as the US Dollar remains at relatively high levels.  On the other hand, the BOM has not forgotten what might happen should the central bank lose control over the Peso.  In 1994, investor confidence strengthened after the implementation of the NAFTA agreement. Foreign capital began to flow in the direction of the Mexican economy. Up until this time the Peso was pegged to the US Dollar. This was accomplished through the use of US Dollar denominated short term notes. However, the NAFTA agreement coincided with domestic political instability, including an armed revolt in one region, causing a reevaluation of risk by foreign investors. The capital inflow stopped. Instead of allowing the Peso to float, the government devalued the Peso when foreign currency reserves ran out. When the government finally did allow the Peso to float, it depreciated out-of-control leading to hyperinflation. Luckily, the NAFTA agreement allowed the US and Canada to assist as well as the IMF and G-7, all cooperating to bailout the financial system. Since then the BOM has conducted policy with autonomy and implemented an overnight target lending rate as well as currency intervention as monetary policy tools.

At the 17 December meeting1, the BOM followed the US Fed with a 25 basis point increase2, raising the target overnight rate to 3.25%; the first increase since 2008. However, the US Dollar and Peso work on different scales and the Peso continued to weaken as the US Dollar strengthened. The chart below highlights BOM rate increases and currency interventions. It should be noted that up until mid-2015, Peso inflation was being well managed, actually achieving a record low rate of 2.88% over 12 months3. It wasn’t until the last quarter of 2016 that the Peso weakened unrelentingly.

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