The year 2013 saw dramatic developments in emerging market currencies. They began the year on a relatively stable to strong note against the US dollar after the US Federal Reserve in late 2012 announced a massive new open-ended onslaught of asset purchases. But with signs of a US recovery deepening, Fed chairman Bernanke in late May signalled that the Fed was considering the best timing for beginning to unwind, or taper, its blistering rate of $85 billion per month of asset purchases. This touched off an immediate sharp reversal in the US treasury market, with US yields rising in anticipation of the Fed’s buying drying up later in 2013.
In global markets, and especially for emerging market countries, the rise in US yields and US dollar served as a general squeeze on liquidity amid the worry that easy US dollar funding would dry up. Most emerging market currencies plunged in response, especially for countries that had developed large current account deficits in recent years after easy liquidity conditions encouraged booming credit markets in these countries and therefore consumption growth that rapidly outstripped less robust growth in exports. India, Turkey and South Africa are examples of countries that were hardest hit by the “taper threat” from the Fed over the summer.
One currency that escaped the worst of the EM weakness was the Mexican peso, where the economic dynamics have diverged from most of its EM peers in recent years. The current account situation did worsen a bit for Mexico over the last year, but is still a relatively modest 2% or so of GDP, a mere fraction of the worst current account offenders like Turkey and South Africa, both at worse than -6% of GDP.
Emerging markets later caught a huge break in September when the Fed failed to reduce asset purchases as was expected due to the worry that the US government shutdown would harm growth and confidence. There may be another round of political wrangling over the budget early next year, but markets will once again be confronted with a reduction of the Fed’s accommodation by the March meeting of the Fed’s FOMC at the latest.
And when emerging markets are inevitably hit with another round of liquidity worries as the Fed unwinds its policy, the Mexican peso should stand tall versus its emerging market peers, who have a much tougher road ahead in ironing out their imbalances. Adding to the tailwinds for Mexico are its proximity and exposure to the US economy, where the recovery should deepen in the New Year after strong fiscal headwinds in 2013.
Investment flows could also support the peso if the Mexican government’s fiscal reform programme to raise greater tax revenue sees rating agencies upgrading Mexico’s sovereign bonds. Another wildcard that could give Mexico and its currency an even bigger boost would be the ending of the Pemex monopoly on the country’s energy production sector to attract external companies to launch new large-scale oil exploration. Lawmakers are discussing measures to open up Mexico’s energy industry as 2013 draws to a close.