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Trade Duty Threats Weigh On MXN

Times have become difficult for December-elected President Andres Manuel Lopez Obrador. US President unexpected threat of implementing tariffs on all exports to the US set for next Monday as well as recent Fitch downgrade and Moody’s negative outlook could push the country into a recession.

Mexico’s heavy reliance on external trade makes the country much more sensitive to potential trade war effects. Total exports contribution to GDP accounts for 35% or over $450 billion, while US exports are estimated at 80% of the total. Therefore, a unique tariff slap from the US of 5% would imply duties of $18 billion worth and if no convincing solutions are presented by Mexican Foreign Ministry to stem illegal immigration, the rise could set at 10% on 1 July and then increase by five percentage points each month until October 25% threshold is reached. Although this scenario is yet far from being reasonable, USD/MXN grew +2.89% as the announcements made by Fitch and Moody’s added oil to the fire. Fitch cut Mexico’s sovereign debt to BBB, at the border between investment grade and junk status, while Moody’s followed S&P and cut its outlook to negative due to AMLO’s $8 billion refinery spending plan, Petroleos Mexicanos, the state-owned and world’s most indebted oil company as well as recent trade tensions with Mexico’s first commercial partner. While the recent decision offsets positive sentiment from last week over USMCA trade of steel and aluminum, we expect Mexican peso to remain under pressure short-term until final call. In the event of a no-deal, we should see upside risks to inflation, which the Banxico would defend by maintaining high interest rates (Overnight rate: 8.25%) and tight monetary conditions, at the cost of economic growth. In the opposite scenario, Mexican peso would benefit from a push. A last-minute deal is however very likely.

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