MXN/USD price forecast as the Fed gets closer to the terminal rate

The Mexican peso (MXN) is one of the most traded currencies in the Western hemisphere, following the US and Canadian dollar. In addition, it has a tight correlation with energy markets, as Mexico is one of the largest oil producers in the world.

As a curious fact, the Mexican peso was the first currency in the world to use the now-famous dollar sign – $.

While not traded as heavily as other currency pairs, the MXN/USD pair is quite liquid, offering access to Latin America growth opportunities.

Mexico historically had higher interest rates than the United States

One interesting fact that makes the Mexican peso attractive is that the interest rates have historically been higher than in the United States. This is important because the two countries share a common border, meaning that that is a lot of commercial interaction between the two countries.

The chart below shows that even during the COVID-19 pandemic, the interest rates in Mexico did not drop below 4%. In comparison, the fed funds rate was cut to the lowest boundary of 0.25%.

By keeping the interest rates higher than the ones in the US, the Banco de Mexico hopes to make the peso more attractive than its US counterpart. Such a strategy is common among emerging economies, and it is especially interesting because the peso correlates with the energy markets. More precisely, with the price of oil.

But now that the Fed is coming closer to the terminal rate, what will happen to the MXN/USD exchange rate?

Peak policy rate in the US is near

The Federal Reserve is close to peak policy rate as inflation gives signs of cooling off. This is the second most aggressive rate hike cycle on record, squeezing emerging markets as they have to pay their debt in the world’s reserve currency.

As such, Banco de Mexico was forced to raise the rates even further to keep the peso attractive.

MXN/USD remains bullish while above the pivotal area

The Mexican peso has outperformed the dollar since the COVID-19 pandemic. It formed an ascending triangle that took two years until the price finally broke higher at the start of 2023.

MXN/USD chart by TradingView

One level, in particular, looks important – the $0.05 level. It is a pivotal one, and it is the level that offered the most resistance during the 2-year long ascending triangle consolidation.

As such, only a drop below the pivotal level would shift the bias from bullish to bearish on the MXN/USD exchange rate. Unless that happens,  bulls will likely step in at every pullback.