Living, Money

The Problem with Predicting Exchange Rates

USD MXN Exchange Rates

In recent years, one of the hardest things to predict has been the Mexican peso/US dollar exchange rate. Just when the peso seemed to be making a comeback, something else happened leading investors to move back into dollars, either buying US Treasury bonds as a safe place to park money (despite very small returns), or buying dollar contracts in futures markets to protect their foreign investments against depreciation of the currencies in which they have invested.

The Mexican peso abandoned its relatively stable trading trading period of ~11 pesos to the dollar in the crisis of 2008 and devalued by over 40%.  During 2009-2010 the currency gradually regained its strength and traded between 11.5 and 13 pesos for most of the period between 2011-2014—albeit with a couple of brief forays into 14.

However, since the autumn of 2014, the Mexican peso came under renewed pressure, consistently selling at rates well above 15 pesos to the dollar.

In September 2016, the currency breached the psychologically-significant 20-peso to the US dollar level at exchange houses and retail banks, with its weakness attributed to volatility in oil markets, a general rise in the value of the US dollar, and uncertainty in the run-up to US elections in November.

Mexico’s peso came under intensified pressure after the US election in November 2016, with the main reason for the latest fall being Donald Trump’s opposition to US companies investing in factories in Mexico, and threats to charge large US import duties on goods manufactured in Mexico. Because no one knows how far this will go — it has yet only affected the auto industry and in a limited way — it’s difficult to predict how the dollar-peso exchange rate will play out.  The Mexican currency has recovered significant ground in 2017 following its all-time lows after the US presidential inauguration in January 2017, and is currently trading in a range between 17 and 18 pesos to the US dollar on wholesale foreign exchange markets.

Mexico’s peso is a free-floating currency on world foreign exchange markets; it’s among the world’s top-10 most-traded currencies, and is the most-traded of Latin America’s currencies.

The weaker peso has its advantages and disadvantages.

To begin with, it makes Mexico’s exports relatively cheaper, and therefore more competitive in the international market; although a currency heading too low can cause unhelpful inflationary pressures domestically.

The lower peso makes vacationing in Mexico a more attractive option, and retirees living here with dollar-denominated pensions will find that their incomes stretch further when purchasing locally-produced goods.

For people with peso incomes, particularly those who travel frequently to the US, or who buy a lot of imported goods, the depreciation of the currency is a definite disadvantage.

One thing that has changed in the past 15 years or so, is that currency depreciation hasn’t been reflected in high inflation in Mexico. In earlier decades, when the currency was controlled at a certain level until it became unsustainable and a devaluation was necessary, an immediate reaction in Mexico would be to put up the prices of goods and services even if they weren’t directly associated with the dollar—local rents, and locally-grown food, for example. This general knee-jerk reaction, with the excuse that “es que subíó el dólar”, would be reflected in general inflation, pushing up the cost of living for everyone.

This exchange rate effect has diminished in more recent times, and today a higher dollar will only add to the cost of things such as imported goods, and products that require imported components.

Currency exchange rate predictions are often based on what economists call “fundamentals”—which include things like the country’s debt payments as a percentage of GDP, its trade balance (Mexico tends to have very small trade deficits), the rate of inflation, economic growth, etc.—but global economic and political events in particular have a tendency to sideswipe economists’ logic: two years ago, experts and surveys predicted the Mexican peso would recover from its then-lows of 15; in the event it has moved to trade lower.

What most people want to know is what the exchange rate will do next, and here the Spanish expression “no tiene palabra,” or “it can’t be trusted,” is relevant. The safest answer to this question is to say that most year-out forecasts are usually wrong—probably more a matter of random error than ineptitude: a banker once described currency forecasting as “a mug’s game.”

See also: The Cost of Living in Mexico

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