Mexico Builds a Currency Wall…and Pays for It!

Late on Tuesday February 21, 2017, the Mexican central bank (Banxico) announced a $20b currency swap arrangement designed to stop the Peso from collapsing.  The first swap auction will occur on March 6, 2017 and will have a similar effect as Banxico selling US Dollar futures up to 12 months out.  The immediate impact was a 2% spike in the USDMXN rate.
The reason Banxico chose the swap, as opposed to direct intervention, is because the swap is a leveraged agreement which means it won’t deplete FX reserves at the same pace as direct intervention. Technically these swap agreements are not a claim on Mexican FX reserves BUT in reality Banxico is not going to default on the swap as long as they have FX reserves.

This type of levered quasi-government backed arrangement can work for a long time, until it suddenly doesn’t. The breaking point comes when Banxico’s short dollar position becomes so large that counter-parties issue a margin call. Mexico is a LONG way from having this happen, but this is how the movie ends.

In the short to medium term, this move should prove to be successful in halting the decline of the Peso. The unknown is the long run impact. For BK’s part, he will be waiting for the trade to turn against Banxico before committing sizable capital to a Peso trade.