Mexico’s Exchange Rate Policy Restrictions on a High Volatility Environment

The Mexican Peso (MXN) is one of the most traded currencies in the world. Such trading volume does not match the relative size of the Mexican economy or its international trade volume. This intensified trading activity is mostly related with the free exchange features of the MXN, as it does not have barriers or taxes that hinder its exchange with other major currencies, and its liquidity. Both features transformed the MXN from a free trading currency of a relatively medium size country into the Latin America financial asset of reference in international markets, particularly in its parity with the US dollar. In this research paper we study the USD-MXN exchange rate volatility, from the policy-maker perspective, and the limits imposed to the central bank to fight speculative attacks towards Mexican currency, as most trading on such parity occurs overseas, away from the country’s regulatory reach. This analysis is conducted taking into account the use of the Mexican currency as a hedge for falling prices in commodities’ international prices, mainly with the use of derivatives on the USD-MXN exchange rate. In this new environement, the source of the exchange rate volatility is not related to flawed economic fundamentals or political uncertainty, as it was in the last decades of the XX century, but, volatility now comes from the existence of financial speculators and other agents that heavily rely on the Mexican peso, mainly in the form of derivatives, to operate in international financial markets.