MXN: Stayin’ alive by hedging Article 2205 – TDS

According to Sacha Tihanyi, Senior Emerging Markets Strategist at TDS, the options market in USDMXN has long been pricing-in the risk of a win in the Mexican Presidential contest by what the market broadly perceived as an economically unorthodox candidate in Andres Manuel Lopez-Obrador.

Key Quotes

“Until the new year, the market had been content to price-in very little (relative to the election risk) in terms of actual risk of NAFTA dissolution, which is not correct in our view considering the potential for the two events to interact negatively ahead of the election.”

“With the next round of NAFTA talks set to begin on January 23rd, we currently see little indication that the stances of the relevant parties have moved any more constructive than the acrimony of the pre-holiday period.”

“Indeed, quite the opposite has been the case, with a focus in Mexican rhetoric on the possibility of life after NAFTA, and the ability of Mexico to economically weather a post-NAFTA world. While this is certainly the case, there will be costs, and certainly damage wrought on Mexican macro assets.”

“Our view however is that the key (and underpriced) nearer term risk is not whether NAFTA exists in a year from now, but whether the U.S. Administration invokes Article 2205, which notifies NAFTA partners to the intent of (but does not obligate) the U.S. to exit NAFTA.”

“Whether or not the ultimate outcome is withdrawal, should the U.S. invoke Article 2205 we believe that Mexican assets will immediately price-in a scenario that assumes the nonexistence of NAFTA, which would have us target 22.00 in USDMXN.”