What Is President Trump’s Impact On The Mexican Peso?
Relations between the U.S. and Mexico have varied over the years. They have ranged from a stable and symbiotic economic partnership in the better times, to sometimes-conflictual relations arising over specific matters often related to drug enforcement, crime and immigration policies.
U.S. policy has often strongly influenced the Mexican economy and currency indirectly through large-scale shifts in the U.S. economic policy stance. Past U.S. presidents have often steered shy of entering direct confrontations or intervention with the country's neighbor to its immediate south. They instead preferred more diplomatic, cordial and fraternal dialogue with Mexico to address matters of mutual interest.
The dynamic of U.S.-Mexico relations has changed dramatically, however, since the rise to political prominence and successful candidacy of U.S. President Donald Trump. It has brought marked repercussions for the price of Mexico's currency, the Mexican peso (MXN), against the U.S. dollar and other major currencies.
Since launching his candidacy in 2015, Trump has drawn attention to the U.S. trade deficit (US$500 billion), and made specific objections to deficits with large trade partners, including China and Mexico. Mexico came under additional heavy criticism from Trump for attracting U.S. companies to its cheap labor market and for lax controls on Mexican emigration to the U.S.
The MXN's first price began responding to comments by Trump in May 2016 when his Republican primary rival, Ted Cruz, dropped out of the presidential race. It became apparent then that Trump was the GOP frontrunner, and that he had a good chance at winning the presidency. Because of its sensitivity to policy remarks by Trump, the U.S. dollar-Mexican peso exchange rate became associated with the term the "Trump trade."[2]
NAFTA
One of the most significant frameworks governing trade between the U.S. and Mexico is the North American Free Trade Agreement (NAFTA). The agreement was signed between Mexico, Canada and the U.S. in December 1992, and implemented in January 1994. The agreement eliminated import tariffs on nearly all goods traded between the three countries with the exception of some agricultural goods, whose import tariffs were phased out over a 15-year period.
During his campaign, Trump singled out NAFTA with harsh criticism, calling it "the worst trade deal ever approved" by the U.S. and saying that if elected his administration would either renegotiate it or break it.
The NAFTA Numbers
Before NAFTA took effect in '93, the U.S. ran a US$1.7 billion trade surplus with Mexico. But by 2016, the trade deficit had grown to US$58.7 billion with Mexico, because the U.S. had imported US$270 billion from its southern neighbor and exported only US$211 billion. Over the same period, U.S. foreign direct investment in Mexico rose from US$15 billion to US$100 billion.
According to an estimate by the Petersen Institute for International Economics (PIIE), the agreement has cost the U.S an average of 15,000 jobs annually. However, for each job lost, the U.S. economy gains US$450,000 from higher productivity and lower consumer prices.
In looking at these numbers, Trump has taken particular aim at U.S. companies that have moved to Mexico to export their goods back to the U.S. at a lower cost.
Time To Renegotiate?
The text of NAFTA allows countries to withdraw from the agreement six months after notifying other members. However, while Trump has sold his plans for restricting trade with Mexico amid support from U.S. workers, his administration may face political resistance from U.S.-based companies that stand to lose from the measures.
Shortly after taking office, Trump signed an executive order signaling his intention to renegotiate NAFTA. His administration's officials have suggested that the government might impose a tariff of up to 20% on incoming Mexican goods, in part to pay for a wall along the U.S.-Mexico border aimed at slowing the inflow of undocumented Mexican immigrants into U.S. territory.
Such a move would be unprecedented for the U.S., whose legislation allows a temporary import tax of up to 15% for a period of 150 days. However, White House officials note that more than 160 other countries use tariffs of 20% or more to control trade flows.
More Bark Than Bite?
It's unclear how far Trump may be able to proceed in enacting policies to alter the trade imbalance between the U.S. and Mexico.
Trade between the nations is highly integrated. Many U.S.-based manufacturers, notably in the auto and electronics sectors, have operations in Mexico and can maintain a global competitive advantage because they pay lower costs by operating there. Also, Mexico is the U.S.'s second-largest export destination after Canada, buying more than US$200 billion annually in U.S. goods.
Oil Price – A "Trump Card" for Mexico?
Even with the trade-relation turmoil with the U.S., Mexico may have a secret weapon—oil. The commodity could help buffer the nation's currency if the Trump administration plays hardball.
Mexico is a large-scale oil producer and approximately 6% of its export revenues come from oil. And about half of its oil exports go to the U.S. If the Trump administration manages to successfully implement pro-growth policies, as has been widely hinted, that factor could pressure global oil prices upward. That would have a beneficial effect for Mexican trade revenues and the MXN.
Impact Of Policy Changes On The MXN
The MXN weakened more than 14% against the dollar from the time when Trump won the Republican nomination in July 2016 through his inauguration on January 20, 2017.
Although it has weakened significantly, the peso has had a history of weakening against the dollar. And there is a possibility that it could weaken still further if the Trump administration follows through with its threats to revoke NAFTA and impose punitive tariffs on incoming Mexican goods. Nearly 80% of Mexico's roughly US$400 billion in annual exports are sold in the U.S., suggesting Mexico's economy could be hurt severely by restricted access to the U.S. market.[11]
By some estimates, the MXN is already undervalued against the dollar and should be due for a strengthening ahead.[12] When that could happen, however, is unclear. Unless the Mexican government can strike a deal with the Trump administration to mitigate the impact of possible punitive trade measures, that moment is not likely to come in the short term. Also, it's particularly unclear how Mexico could quickly make up for lost trade revenues from the U.S. if its goods are levied with heavy import tariffs.
The peso, alongside other emerging market currencies, may face weakening periods if the U.S. Federal Reserve raises interest rates in response to a growing economy. It's possible Mexico and some other emerging market countries will have to raise interest rates to counteract currency outflows brought by Fed rate tightening.
The real impact of Trump's policies may be widely spread and difficult to gauge. During his presidency, the peso has broken below the 20 per dollar mark, and is projected to continue weakening from there over the long term. But as the MXN floats freely against the dollar, it has reacted to any possibly negative factors immediately by weakening.[13]
Meanwhile, the MXN's weakening may be a positive factor for Mexico's trade balance and balance of payments. Also, it could reinforce its trade surplus with the U.S. by making Mexican goods for export still cheaper, and U.S. goods for export to Mexico more expensive.
Summary
The Mexican peso has weakened severely under threats by U.S. President Donald Trump to unravel NAFTA and impose tariffs on trade with Mexico.
Under normal circumstances, the MXN would be considered to be undervalued against the dollar and other currencies. However, in the face of the threats to its U.S., trade the currency could be subject to additional weakening ahead.
At some point in the future, the peso will be poised for a strengthening. When that happens will depend on several factors, including the severity of trade restrictions imposed by the U.S. and the U.S. economy's pace of growth under the Trump administration. But until those and other factors are defined, traders will look for the MXN to continue to follow a path of weakening against the dollar.
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References
Retrieved 10 Oct 2015 https://www.bcb.gov.br/ | |
Retrieved 10 Oct 2015 http://www.casadamoeda.gov.br/ | |
Retrieved 10 Oct 2015 https://mpra.ub.uni-muenchen.de/42174/1/Easing_trade_costs_within_Mercosul-V3-MPRA.pdf | |
Retrieved 10 Oct 2015 https://www.realclearmarkets.com/blog/BrazilianExchangeRate_06302011%5B1%5D.pdf |
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