Peso Plunges as Shrinking Rate Gap Reduces Attractiveness of Carry Trades

The Mexican peso has suffered its worst week since March, falling by 2.75% against the US dollar. The USD/MXN exchange rate has risen to around 17.71 pesos per dollar, up from a low of 16.90 in September. This significant jump is largely due to changes in monetary policy.

Banxico, Mexico's central bank, kept its benchmark interest rate at 6.50% on September 24, while the US Federal Reserve raised its policy rate to 3.75%-4.00%. The shrinking gap between these rates has reduced the attractiveness of carrying trades involving the Mexican peso.

Investors had been borrowing in lower-yielding currencies and holding peso-denominated assets to capture the interest rate differential. However, with Banxico's rate now only 2.5 percentage points higher than the Fed's upper end, this spread is shrinking rapidly.