Last week brought a number of big developments for emerging market currency traders, but the two biggest were the ECB’s new easing measures and the Bank of Mexico’s shocking interest rate cut.
We’ve already covered the implications of the European Central Bank’s decision on G10 currencies here and here, but the decision could also have a big impact in emerging markets as well. When the Federal Reserve first started tapering its Quantitative Easing program, EM currencies fell sharply on expectations of decreased global liquidity. While the volatility has died down since then, the implicit tightening from the world’s most important central bank has still served as a headwind for EM currencies in the first half of the year.
However, with Thursday’s European Central Bank decision, the global liquidity baton has been passed across the Atlantic. ECB President Draghi also stated that the ECB was not finished easing, so as long as the ECB continues to replace lost liquidity from the Fed, EM currencies should be generally supported in as we move through the summer.
The other massive development from last week was the Banxico’s decision to cut interest rates 50bp down to 3.0%. Exactly zero analysts were calling for this move in a pre-meeting Reuters poll, and in fact, many thought that the central bank was more likely to raise interest rates before cutting.
In its statement, the bank expressed concern with the widening output gap and a weak outlook for GDP, but also indicated that additional cuts were unlikely. As a result, we currently view this move as a “one-off” and still believe the Bank of Mexico will raise interest rates at some point next year.
EM Pair in Play: USDMXN
Not surprisingly, our EM Pair in Play for this week is the USDMXN, which has rocketed higher since the Banxico’s surprising rate cut. Looking to the chart, the pair put in a large daily Piercing Candle* off previous support at 12.83 on Friday and has followed that up with a breakout above the 5-month bearish trend line and 50-day moving average today.
The secondary indicators also confirm the shift to a more bullish outlook: the pair’s MACD is turning higher and nearing the key “0” level, while the RSI is on the verge of breaking the 60 area that typically caps the indicator in downtrends.
Moving forward, the next stop for the pair may be the 200-day MA, which currently comes in around 13.07, followed by the 38.2% Fibonacci retracement at 13.12. Meanwhile, any near-term pullbacks may now find support on the topside of the broken bullish trend line near 12.95.
*A Piercing Candle is formed when one candle opens near the bottom of the previous candle's range, but buyers step in and push rates up to close in the upper half of the previous candle's range. It suggests a potential trend reversal.