Peso Declines Following President-elect's Judicial Reform Announcement

Key Takeaway

• The Mexican peso fell 1.7% against the dollar after President-elect Claudia Sheinbaum announced plans for judicial reform, marking a significant move in emerging-market currencies.
• The peso's one-month volatility surged to 19% from 9.2%, reflecting market unpreparedness and potential challenges for carry traders.
• Proposed reforms by the Morena party could deter foreign investors, while high yields (11.25%) may attract carry traders if volatility subsides.

Peso Decline Following Reform Comments

The Mexican peso experienced a significant drop after President-elect Claudia Sheinbaum announced that a proposed reform of the nation's judicial system would be among the first topics discussed in congress. The currency fell as much as 1.7% against the dollar in early Asia trading following her comments, marking the strongest move in emerging-market currencies amid thin liquidity. The dollar index rose by 0.1% during the same period.

Sheinbaum's comments were delivered during a speech late on Monday in Mexico City. She also mentioned that she would name her cabinet next week and expressed her belief that the reform discussions would not impact the peso. However, the market reaction suggests otherwise, with the peso's decline extending into the Asian time zone.

Market Reaction and Volatility

The peso's recent performance has been notably volatile. According to Sebastian Boyd, the currency's washout over the past week has been brutal, and the recovery may take time. The peso was a crowded long position, and it collapsed following the better-than-expected showing of the Morena party in the June 2 election. Long MXN, short JPY positions returned 32% in the 12 months through May, but this has now fallen to 18%, less than the S&P 500's performance.

The attractiveness of the peso's carry trade may come to predominate as long positions have been washed out. However, if volatility remains high, other options for carry traders may become more appealing. The peso's one-month volatility doubled following the election, rising to 19% from 9.2% a week before the vote, highlighting the market's lack of preparedness.

Political and Economic Implications

The actual market impact of the Morena party's proposed constitutional changes is theoretical and long-term. The proposed reforms include scrapping independent regulators and making judges elected at all levels, which could be off-putting to foreign investors. However, these changes would take a long time to feed through into fundamentals.

The peso's weakness over the past week may keep the central bank on hold, meaning interest rates could stay higher for longer. The peso's three-month implied yield stands at 11.25%, compared to 5.4% on US Treasury bills and -0.12% on the Japanese yen. This high yield could attract carry traders if volatility decreases.