Mexican Peso: More Losses Possible Warn Analysts

File image of Claudia Sheinbaum. Image copyright Claudia Sheinbaum.

Mexican Peso dropped sharply after a landslide victory for Claudia Sheinbaum and the left-wing Morena Party puts Mexico's system of checks and balances in jeopardy.

Claudia Sheinbaum easily won the Presidential elections in Mexico, but the surprise for markets was the dominant showing by her Morena party, which will allow it to amend the constitution.

"Although Sheinbaum's victory was priced in, the increased representation of the ruling coalition in Congress is spooking the markets," says Luis Hurtado, an analyst at CIBC Capital Markets.

Preliminary results show that the ruling coalition could obtain between 346-380 seats in the Chamber of Deputies and 76-88 seats in the Senate.

"It's full-blown carnage in the MXN overnight as the ruling Morena party has won in a landslide election," says W. Brad Bechtel, Global Head of FX at Jefferies LLC. "The landslide result puts her charge of a super majority in the house and a simple majority in the Senate. The fear then is that they might pass legislation to alter the constitution or other such drastic measures which could adversely impact the economy."

These results mean Morena and its allies secure a qualified majority in the Chamber of Deputies and will likely do the same in the Senate - "a situation that considerably increased the odds of the approval of controversial constitutional reforms," says Hurtado.

The Pound to Peso exchange rate surged by as much as 4.50% at one stage before paring the advance to 2.50% (22.22), the Dollar to Peso exchange rate is up 2.30% on the day at 17.45 and the Euro to Peso exchange rate is up 3.0% at 18.92.

Above: GBP/MXN's surge turns the technical picture decisively constructive. Although, near-term, it is overbought (RSI well above 70, lower panel). Track MXN with your own custom rate alerts. Set Up Here 

CIBC says the election outcome amounts to a "negative scenario" whereby the ruling coalition has a qualified majority in both chambers and expects further Peso weakness in the short term.

CIBC's analysts say Morena's dominance will likely trigger constitutional reform, which will weaken the justice and electoral systems and eliminate some regulatory bodies.

In addition, Sheinbaum can appoint four Supreme Court Ministers during her mandate, bringing the number of Supreme Court members loyal to Morena to four as early as the end of this year. This can prevent the court from declaring any future reforms unconstitutional.

Bechtel says positioning on MXN was substantial heading into the election. This, combined with relatively poor liquidity, can spawn outsized moves.

"The move from 16.50 just a week or so ago to 17.68 now is pretty drastic, but we could easily see 18.00 or more before all is said and done here," he adds.

Under previous President, Andrés Manuel López Obrador, the left-wing coalition had been frustrated in its attempts to increase social spending, reform the Supreme Court, shrink the number of lawmakers, bolster the power of state-owned companies, and eliminate independent regulators.

Markets were simply not prepared for an outcome that now effectively allows such outcomes.

Karl Schamotta, Chief Market Strategist at Corpay, says Mexico's elevated interest rates mean the Peso will remain an attractive currency and it could retain its "superpeso" sobriquet for now.

However, he notes foreign exchange markets remain wary of downside risks. "Options markets - where participants take out insurance against undesired shifts in spot rates - are heavily skewed, with a drop in the peso considered far more likely than an equivalent move higher over the coming twelve months."

"Sheinbaum is inheriting an economy saddled with slowing growth, poor infrastructure, elevated welfare spending, widening budget deficits, and rampant security problems - and there’s little doubt the peso is overvalued at current levels," he adds.