According to BNY’s Geoff Yu, Latin American foreign exchange (FX) and equities have become a single, crowded 'total return' trade, with all regional currencies remaining net overheld, while sovereign bond holdings are beginning to reverse unevenly across the region [1]. In Mexico, expectations for lower interest rates are driving increased FX hedging activity ahead of a likely 25 basis point rate cut by Banxico later this week, even as demand for Mexican sovereign bonds remains firm [1].
Yu notes that iFlow data throughout the year has indicated that Latin American equities and currencies are essentially the same position, with every Latin American currency still net overheld and, until recently, every sovereign bond market also comfortably overheld [1]. Despite the region offering liquidity and attractive real yields, these holdings are now starting to reverse, though the process is uneven [1].
In Mexico, the clearest evidence of shifting expectations is seen in the increased hedging interest, driven by anticipated lower rates, while sovereign bond interest stays robust [1]. The market is likely interpreting Banxico’s policy approach as moving towards stimulus and growth, with the central bank compressing the real rate buffer to the minimum, which Yu believes should be at least 100 basis points to justify positive real rates [1]. Banxico is seen as pre-empting idiosyncratic downside risks, setting it apart from other global emerging markets [1].
Yu also highlights that idiosyncratic risk from the U.S. remains high, stemming from the swift transmission of less dovish policy expectations and potential challenges in upcoming trade negotiations [1]. If markets and the carry trade are sufficiently forward-looking, FX hedging is expected to increase in size, while fixed income markets may remain resilient due to limited fiscal impulse [1].
CONCLUSION
BNY’s analysis suggests that expectations for a Banxico rate cut are driving increased FX hedging in Mexico, even as sovereign bond demand remains steady. The market is positioning for potential policy shifts and external risks, with the carry trade dynamic and real rate compression in focus. Overall, the outlook points to heightened hedging activity and cautious resilience in fixed income.