Mexico’s Manufacturing Boom Lifted Peso to 5-Year HighCME: USD/Mexican Peso ( CME:6M1! )
What’s the strongest currency in 2023? Hint: Not the US dollar.
• Although dollar index has rallied nearly 6% in the past two months, it gained just 2.1 points, or +1.9%, year-to-date, to settle at 105.583 as of September 22, 2023.
• British Pound futures ( SEED_TVCODER77_ETHBTCDATA:6B ) was up 2.0% YTD, to close at $1.225 per pound sterling.
• Euro FX ($6E) gained a meager 0.7% YTD, to $1.069 per euro.
• Chinese Yuan ( FWB:CNH ) declined 5.5% YTD, from 6.991 to 7.295 yuan per dollar.
• Japanese Yen ($6J) has lost over 11% YTD, from 130 to 146 yen per dollar.
While most foreign currencies were under pressure as the US Federal Reserve embarks on the monetary tightening journey, Mexico boasts the world’s strongest currency this year.
• Each dollar was exchanged for 19.70 Mexican Peso on January 1st. The exchange rate is now 17.41 as of last Friday. For the Peso, this represents a 12.7% gain.
The strength of the Peso is built upon Mexico’s thriving economy. Riding on the waves of resurgent exports and booming manufacturing, Mexico has overtaken China as the biggest US trading partner. According to the latest US Census Bureau data, Mexico made up 15% of US imports in July, while China had a 14.6% share.
From Offshoring to Nearshoring
For decades, U.S. companies moved manufacturing offshore to lower production cost. Free trade helped grow global economy and lift the living standard of poorer nations.
However, the world has experienced a series of trade disruptions lately: the US-China trade conflict, the Covid-19 pandemic and its supply chain disruptions, the Russia-Ukraine conflict and the export controls that followed. Their cumulative impact has called into question the vision of a globalized economy.
To “de-risk” the potential disruptions in global supply chain, new trends has emerged to replace offshoring, namely, “Reshoring”, “Friend-shoring” and “Nearshoring”.
Reshoring is the opposite of offshoring, with US companies bringing production back to the States. According to the “Reshoring Initiative 2022 Data Report”, this phenomenon contributed to the creation of 360K manufacturing jobs in 2022.
• Cross-checking this claim with BLS nonfarm payroll data, I found that manufacturing employment is 13.0 million in August, up 106K year-on-year. “Made-in-America” is one of the reasons supporting a solid US job market.
• While reshoring raises the cost of production, robotics and industrial automation offset some of the labor costs. Government funding and tax incentives also help.
Friend-shoring encourages companies to shift manufacturing away from authoritarian states and toward allies with shared values. Countries such as India, Vietnam, Mexico, Indonesia, Malaysia, South Korea, Japan, and Brazil could benefit from friend-shoring as plants, jobs and investments move toward these nations deemed sufficiently trustworthy by the United States.
• Diversifying the concentration of global supply chain also helps businesses become more resilient to shocks like war, famine, political change, or the next pandemic.
Nearshoring is one step down from reshoring. The key word is “Near”. By placing plants in North and Central America, particularly in Mexico, US companies could source imports from closer to home.
• In addition to lowering production cost, nearshoring also has the benefits of cheaper transportation, lower import tariffs, shorter production cycle, and faster response time.
• Spanish, a common language, stands as a unique advantage for training local workforce and better communication between the US customers and their nearshoring suppliers.
The Next World Factory
Mexico stands to benefit from both friend-shoring and nearshoring. Made-in-Mexico-for-America is nothing new. It started in 1994 with the signing of North American Free Trade Agreement (NAFTA). However, it did not give a big boost for Mexico then. Since the year it took effect, Mexico’s economy grew at 2.0-2.5% a year, well below par for developing economies, and nowhere near enough to lift millions of Mexicans out of poverty.
We could make the case that things would be very different this time. Tesla’s Monterrey Gigafactory serves as a textbook case of why it would work.
Two years ago, when Tesla announced plans to open a factory in Texas, it also proposed to build a Gigafactory in Monterrey, the capital of Nuevo León state. Instead of shipping auto parts all the way from China, it made sense to build them close to the US border. “You could drive to California from Monterrey in 3 hours without seeing a red light”, a big advantage promoted by Nuevo León’s trade office.
Tesla’s decision triggered a sea change in its supply chain. AGP Group makes windshields, China’s DSBJ makes electronics parts, Italy’s Brembo SpA makes brake— and they’re all setting up new factories near Monterrey. All told, more than 30 companies have moved to Nuevo León since Tesla’s announcement.
Foreign direct investment in Mexico is already up more than 40% in 2023. Ultimately, Mexico’s appeal to global businesses rests on its geography and its free trade agreement with the U.S. Comparing to other alternatives, Mexico is attractive because it’s already integrated into the U.S. More investment will flow in as big companies bring their plants and the entire supply chains there one-by-one.
While manufacturing for the US is concentrated in dozens of mega industrial parks close to the US-Mexico border now, the growth potential is huge. I am convinced that Mexico would be the next World Factory. “Made-in-Mexico” will be like “Made-in-China” today.
Trading Idea with Mexico Peso Futures
On May 16, 1972, the IMM (now part of the CME Group) launched seven currency futures contracts: British pounds, Canadian dollars, Deutsche marks, French francs, Japanese yen, Mexican pesos, and Swiss francs. This marks the birth of financial futures, the first time a futures contract is based on something other than physical commodities.
The USD/MXN futures ($6M) is one of the earliest financial futures contracts. It is notional on 500,000 Mexican pesos. At Friday closing price of 0.057430, each December 2023 contract (6MZ3) is valued at $28,715. Initial margin for buying or selling one contract is $1,400.
On September 14th, the day before Triple Witching Day, the Peso futures reached a high volume of 224,296 contracts, with open interest standing at 252,004.
Aside from the fundamental economic factors, the near-ending of Fed rate hikes means that interest-rate parity is in favor of the Pesos.
When the world has been focusing on the 525-bp Fed rate hikes in the past two years, Mexico’s Central Bank raised interest rates by 725 basis points during the same period, from 4.0% all the way to 11.25%.
At 0.5675, the USD/Peso exchange rate is at 5-year high. However, this is nowhere near its all-time high of 0.1099 reached in March 2002. I am bullish on the Pesos based on the analysis discussed here and would explore a long position.
Record export data and new announcement of foreign direct investment could lift the Pesos up further. The risk in long Peso would be the Fed raising interest rates again in November or December meeting.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
