If protectionism is about to be unleashed by Donald Trump on America’s closest trading partners, foreign exchange traders are acknowledging the threat in a funny old way.
On Wednesday, when Mr Trump issued an executive order to build a wall on the Mexican border, the peso rallied more than 2 per cent. Since slumping to a record low of 22.03 pesos two weeks ago, the currency has shot up almost 5 per cent.
The rebound needs to be seen in context: the peso has lost more than 12 per cent of its value over the past year amid persistent threats from Mr Trump to redefine America’s relationship with its biggest trading partners, Mexico and Canada, by rewriting the North American Free Trade Agreement. Nafta makes up about $1tn of US trade.
Protectionism was central to Mr Trump’s “America First” inauguration address, while his commerce secretary nominee, Wilbur Ross, has promised to make Nafta “the first thing for us to deal with”.
Yet the closer the possible implementation of the Trump administration’s protectionist policy gets, the less the currency market appears bothered. The Canadian dollar has appreciated almost 3 per cent this year.
Words are one thing, but investors’ doubts about whether the administration is capable of delivering not just protectionism but the much-vaunted promise of fiscal stimulus and tax cuts, are holding the dollar back. The dollar index, a broad gauge of the greenback, fell to a 10-week low this week.
Those doubts are hastening a reappraisal across currencies, including the much-maligned peso. There is some market chatter about the peso’s cheapness. “It’s a good opportunity to go long the peso,” says one FX trader in Mexico City who puts the sharp rally on Wednesday down to investors taking profits on long dollar positions.
Nonetheless, few are likely to be hanging on to long peso positions for too many trading sessions — not until there is further clarity from the White House about the future of Nafta and the shape of US protectionism.
After all, the case against the peso is compelling — a big current account deficit, a drain on reserves, rising inflation, low growth, worries about foreign direct investment, the threat of a credit ratings downgrade and, of course, the new White House occupant.
“This year is going to be a difficult one for Mexico overall,” the FX trader says.
The case for an upbeat reassessment of the Canadian dollar, colloquially known as the “loonie”, is more plausible.
US protectionism is just as worrying for Canada as it is for Mexico. Nearly three-quarters of Canada’s exports go to the US. Ian Gordon, a currency strategist at Bank of America Merrill Lynch, says the loonie has the highest degree of sensitivity among G10 currencies to movement in the terms of trade. So a 10 per cent hit to Canadian trade terms implies an equivalent-sized drop in the trade-weighted Canadian dollar.
Further pressure on the loonie, which draws its nickname from the aquatic bird on the C$1 coin, comes from the growing divergence between interest rate policies in Canada and the US, which — with the Federal Reserve expected to raise rates three times in 2017 — should benefit the US dollar.
However, the odd thing, explains Mr Gordon, is that the correlation between the loonie and the US dollar is at its strongest in six years, “suggesting markets expect positive spillovers from US stimulus”.
There is a pushmi-pullyu trend in loonie trading. The recovery in oil, Canada’s biggest export, and the prospect of Canada benefiting from US stimulus are as positive for the loonie as rates divergence and the ripping up of Nafta are negative.
Dollar-loonie trading is torn between these competing fundamentals, says Stephen Gallo of Bank of Montreal, and “this offset of fundamentals is likely to remain all year”.
There are, of course, several factors that could upset that scenario. One is the pace of the Federal Reserve’s hiking cycle. Another is the oil price. Opec’s agreement on supply cuts that drove oil’s rally last quarter, means “the market remains in its sway”, says Neil Mellor, BNY Mellon’s FX strategist.
And while oil has held its own in the face of a rising dollar, the black stuff tends to have an inverse correlation with the greenback, so is more vulnerable when the dollar rises. And a stronger dollar remains a popular forecast among currency analysts.
The factor that worries Canada the most is trade disruption. For now, the US administration is offering reassuring words to the Trudeau government. Stephen Schwarzman, Blackstone chief executive and chair of the president’s business leaders panel, this week said Canada was well regarded by the US administration and should not be worried by protectionism.
For Mexico, the words from the White House have been uncompromising. The tests won’t end for the peso.