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Mexico’s peso has gained 3.2% against the U.S. dollar in early 2025, but Wells Fargo foresees potential weakening ahead. The bank deems the currency overvalued, facing risks from possible U.S. tariffs, a likely recession, and the threat of sovereign credit downgrades.
Wells Fargo forecasts Mexico’s GDP growth at a mere 0.1% for this year, suggesting a recession may emerge by the second quarter. The situation could worsen if 25% tariffs are enacted in April, potentially deepening the economic downturn.
Risk Of Sharp Peso Decline
While peso depreciation may occur gradually due to “tariff fatigue” and diplomatic efforts, the risk of a sharp decline persists. The bank does not expect intervention from the Bank of Mexico in currency markets should the peso weaken, indicating an adjustment based on economic fundamentals.
The existing information points to a clear concern regarding the relative strength of the Mexican peso, particularly in the context of external and internal economic pressures. Although it has appreciated by just over three percent against the dollar so far this year, analysts at Wells Fargo argue that its current value may not be justified when viewed against the broader economic backdrop. Rising fears about a downturn in the United States—Mexico’s largest trading partner—alongside anticipated tariffs and fiscal concerns, paint a challenging picture for the months ahead.
The GDP forecast, set at a near-zero growth rate for the entirety of 2025, underscores the anticipation that the economy could stall or reverse. Timing is key here—by the second quarter, activity may show enough contraction to qualify as a technical recession. Whether that materialises will depend greatly on developments in cross-border trade, especially with tariff policy expected to become more concrete by April. Should these penalties climb to 25%, the drag on industrial production and export volumes would be difficult to ignore.
From past patterns, we recognise that markets can sometimes adjust slowly to mounting stress—what’s often referred to as “tariff fatigue” tends to temper knee-jerk currency reactions. That said, there’s still an elevated possibility that sentiment could shift sharply and without much warning. A sudden re-pricing of risk, especially if coupled with revisions to Mexico’s credit rating, could set off a faster move in spot FX.
Implications For Derivatives And Volatility
For those of us involved in derivatives, the message is unambiguous: the conditions point to asymmetry in currency downside risks. Near-term products may offer some scope to benefit from prolonged peso strength, especially if diplomatic progress delays tariff enforcement. Yet beyond roll dates in Q2, demand for protection appears likely to increase. Vega levels may currently appear subdued, but longer-dated implied vols could be underestimating the tail risk associated with trade policy moves and potential rating action.
We’ve already begun reassessing positioning on the short-dated curve. Skews are still relatively balanced, but any renewed swing in dollar demand might quickly change that. Options tied to MXN should be scrutinised for Delta adjustability, particularly for structures exposed to a reversal in weighty carry trades. Importantly, Bank of Mexico’s expected abstention from direct intervention offers another layer of confidence that valuations will remain tied closely to GDP indicators, external balances, and broader risk-off moves out of emerging markets.
In technical terms, it’s time to keep a close eye on any break of recent support intervals. Spot levels inching beyond those thresholds without sign of strong institutional resistance could hint at a pending acceleration. The options market, for now, reflects only a mild pickup in hedging activity, suggesting the balance of conviction still lies with moderate mean-reversion. That will not remain the case if forward guidance begins to deteriorate alongside a worsening trade stance. We see value in putting early strategies in place, especially if delta-neutral positions can be structured using liquid tenors and well-priced vol surfaces.
Charting isn’t giving major alerts yet—but remember, it only ever does so with hindsight. Let the spreads tell the story, and lean on them before the story gets crowded. Instructions should already be filtering out across desks to adapt to this. It’s no longer about reacting—it’s about being awake just before the overshoot begins.
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