Recent developments in the Mexican Peso market March 2009 1
Index 1. The FX market before the financial turmoil 2. What we got right what we missed 3. Structural change in the FX market 4. Final remarks 2
Development of financial markets Favorable global environment Structural policies and secondary building blocks Foundations Prudent fiscal and monetary policies Commitment to a market determined exchange rate Unrestricted capital mobility Adequate legal and regulatory structure Development of local yield curve Pension system reforms 3
Positive impulse for MXN volume Average Daily Volume for Selected Currencies In billions of USD and percentage share of total volume* 2004 2007 Volume % share Volume % share Dollar (USA) 1,573 88.7% 2,659 86.3% Euro (EU) 660 37.2% 1,140 37.0% Yen (Japan) 360 20.3% 508 16.5% Pound sterling (UK) 300 16.9% 462 15.0% Swiss franc (Switzerland) 108 6.1% 210 6.8% Peso (Mexico) 20 1.1% 39 1.3% Rand (South Africa) 14 0.8% 28 0.9% Zloty (Poland) 7 0.4% 25 0.8% Rupee (India) 5 0.3% 22 0.7% Real (Brazil) 4 0.2% 12 0.4% Forint (Hungary) 4 0.2% 9 0.3% Koruna (Czech Rep.) 4 0.2% 6 0.2% Baht (Thailand) 4 0.2% 6 0.2% * Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%. Source: BIS. Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity. 4
liquidity Average USD/MXN bid-ask spread Local time; Mexican peso cents (1H2008) 0.35 0.30 0.25 0.20 0.15 0.10 07:00 07:58 08:56 09:54 10:52 11:50 12:48 13:46 Source: Reuters. 5
and trading hours. Trading timeframe in the USD/MXN foreign exchange market Average trades per minute (1H08) 14 12 Chicago pit opening London market close 10 8 6 4 2 0 06:00 06:58 07:56 08:54 09:52 10:50 11:48 12:46 13:44 14:42 15:40 Source: Reuters. 6
Index 1. The FX market before the financial turmoil 2. What we did right what we missed 3. Structural change in the FX market 4. Final Remarks 7
Financial development reduced vulnerabilities. Ratio of central government external debt over domestic debt Percentage 50 45 40 35 30 25 2001 2002 2003 2004 2005 2006 2007 2008 Jan-09 20 8
Foreign currency leverage is low. Gross external debt position by sector Millions of U.S. Dollars and % of GDP 1994 2002 2008* Millions of Millions of Millions of % of GDP % of GDP % of GDP dollars dollars dollars Public Sector 85,436 18% 78,818 11% 56,939 5% Short Term 6,354 1% 2,789 0% 1,275 0% Long Term 79,082 17% 76,029 11% 55,664 5% Private Sector 45,137 10% 77,101 11% 76,468 7% Short Term 22,403 3% 24,734 2% Long Term 54,698 8% 51,734 5% TOTAL 130,573 28% 155,919 22% 133,407 12% * Data of public sector debt as of December 2008, data of private sector debt as of September 2008. Source: Banco de México. 9
Manageable current account deficit. Balance of payments forecast, 2009 Million U.S. dollars 2008 2009 Current account -15,527-24,100 Trade Balance -16,838-26,375 Oil trade balance 14,365 5,695 Non-oil trade balance -31,203-32,070 Non factor services -7,006-4,911 Factor services -17,151-15,250 Transfers 25,468 22,437 Capital Account 20,961 27,469 Liabilities 29,321 20,729 Indebtedness 7,986 6,229 Public Sector 1/ -3,928 9,829 Private Sector -939-3,600 PIDIREGAS 12,853 Foreign Investment 21,335 14,500 Assets -8,360 6,740 Errors and omissions 2,016 Change in international net reserves 7,450 3,369 For 2009, PIDIREGAS are included in the Public Sector indebtedness Source: Foreign Exchange Commission. 10
These developments were reflected in the low volatility of the exchange rate. Implied volatility of the OTC* options (USD/MXN) Percentage 80 70 60 50 40 30 20 10 0 Jan- 01 Sep- 01 May- 02 Jan- 03 Sep- 03 May- 04 Jan- 05 Sep- 05 May- 06 Jan- 07 Sep- 07 May- 08 Jan- 09 Source: Bloomberg. *1 month. 11
Stability encouraged excessive risk taking by some players Firms used derivatives without adequate risk assessment capabilities Banks overexposed clients and themselves Rating agencies overlooked important operations Authorities failed to identify the perverse incentives generated by the low volatility 12
Pay-Off estimated from a USD/MXN target forward Pesos 30.00 20.00 If USD/MXN < 10.60 then sell 10 US millions at 10.60 If USD/MXN > 10.60 then sell 20 US millions at 10.60 10.00 Strike price 10.60 0.00-10.00 SPOT 10.12 Forward 10.37-20.00-30.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50 12.00 12.50
Index 1. The FX market before the financial turmoil 2. What we got right what we missed 3. Structural change in the FX market 4. Final Remarks 14
Factors behind the structural adjustment Macro factors Global risk aversion Terms of trade shocks Contraction in trade Tightened credit conditions No Decoupling 15
Reduction in the number of participants Average daily volume of local financial institutions with US investment banks Percentage, millions of US dollars Spot volume share Average daily volume in the spot market 2007 2009 2007 2009 Investment banks 8.2% 1.8% 400 88 Source: Banco de Mexico 16
Reduced leverage Open interest of the USD/MXN contracts in the CME Millions of US dollars (ma 10 days) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Source: Chicago Mercantile Exchange. 17
Increased transaction costs Average USD/MXN bid-ask spread (ma 10 days) Mexican peso cents 2.50 2.00 1.50 1.00 0.50 0.00 Jan- 08 Feb- 08 Mar- 08 Apr- 08 May- 08 Jun- 08 Jul- 08 Aug- 08 Sep- 08 Oct- 08 Nov- 08 Dec- 08 Jan- 09 Feb- 09 Mar- 09 Source: Reuters. 18
Thinner markets Ratio between volume and trades Millions of US dollars per trade 3.2 3.0 2.8 2.6 2.4 2.2 2.0 1.8 1.6 1.4 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Source: Reuters. 19
Severe fall in trading volumes Daily spot volume in the local FX market Millions of US dollars (ma 10 days) 7,500 6,500 5,500 4,500 3,500 2,500 1,500 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 Source: Banxico. 20
Negative feedback process The dynamics of the exchange rate were aggravated by the derivatives structures of a handful of local companies. The structural adjustment that was taking place in the FX market reduced the capacity to absorb extraordinary dollar demands coming from these firms. The first wave of official intervention was aimed at breaking this negative feedback process. 21
Official intervention Extraordinary auctions: provide liquidity to tackle exceptional foreign exchange demands. Daily auctions (minimum price): provides liquidity when the exchange rate moves significantly. Direct sales: provide two way risk. Daily auctions (no minimum price): predictable sale of surplus accumulation. Amounts* sold in the Mexican FX market Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09** Total Extraordinary auctions 11,000 - - - - - 11,000 Daily auctions (400 US millions) 2,096 1,285 797 988 1,092 400 6,658 Direct sales - - - - 1,835-1,835 Daily auctions (100 US millions) - - - - - 500 500 Total 13,096 1,285 797 988 2,927 900 19,993 Source: Banxico. *Millions of US dollars. **Amount changed from 400 US millions to 300 US millions by the Foreign Exchange Commission 22
The move to discretionary policy Starting in February, the Peso faced a series of challenges: Growing global uncertainty about the timing and strength of a recovery More pessimistic estimates on the local economy More tightened conditions for external financing Opportunistic positioning that took advantage of daily auction mechanism Intraday USD/MXN exchange rate and Banxico's daily auctions Pesos per dollars USD/MXN exchange rate and Dow Jones Index Pesos per dollars*, units 14.8000 14.6000 First direct sale by Banxico 14.00 14.10 14.20 <-- Mexican peso Dow Jones --> 8,300 8,200 14.4000 14.30 8,100 14.2000 14.0000 14.40 14.50 14.60 8,000 7,900 13.8000 26 Jan 26 Jan Source: Reuters. 27 Jan 28 Jan 29 Jan 30 Jan 30 Jan 03 Feb 04 Feb 04 Feb 05 Feb 06 Feb 06 Feb 10 Feb 10 Feb 11 Feb 12-Feb 14.70 02 Feb 03 Feb 04 Feb 05 Feb 09 Feb Source: Bloomberg. *Inverse order values. 23 7,800
Equilibrium and two way risk Implied probability density function in USD/MXN one month options 0.50 0.45 0.40 February 03rd, 2009 March 13th, 2009 January 14th, 2009 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 9 11 13 15 17 19 21 Pesos per dollar Source: Banco de México and Reuters.
Encouraging results in the beginning. USD/MXN exchange rate (February 4, 2009) Pesos per dollars 14.75 14.70 14.65 14.60 USD/MXN exchange rate (February 27, 2009) Pesos per dollars 15.30 15.25 15.20 14.55 15.15 14.50 15.10 14.45 15.05 14.40 15.00 Source: Reuters. 25 12:17:00 p.m. 06:01:00 a.m. 06:27:00 a.m. 06:53:00 a.m. 07:19:00 a.m. 07:45:00 a.m. 08:11:00 a.m. 08:37:00 a.m. 09:03:00 a.m. 09:29:00 a.m. 09:55:00 a.m. 10:21:00 a.m. 10:47:00 a.m. 11:13:00 a.m. 11:39:00 a.m. 12:05:00 p.m. 12:31:00 p.m. 12:57:00 p.m. 01:23:00 p.m. 01:49:00 p.m. 02:15:00 p.m. 02:41:00 p.m. 03:07:00 p.m. 03:33:00 p.m. 03:59:00 p.m. 06:02:00 a.m. 06:27:00 a.m. 06:52:00 a.m. 07:17:00 a.m. 07:42:00 a.m. 08:07:00 a.m. 08:32:00 a.m. 08:57:00 a.m. 09:22:00 a.m. 09:47:00 a.m. 10:12:00 a.m. 10:37:00 a.m. 11:02:00 a.m. 11:27:00 a.m. 11:52:00 a.m. 12:42:00 p.m. 01:07:00 p.m. 01:32:00 p.m. 01:57:00 p.m. 02:22:00 p.m. 02:47:00 p.m. 03:12:00 p.m. 03:37:00 p.m. Source: Reuters.
USD/MXN exchange rate and Dow Jones Index (February 27, 2009) Pesos per dollars*, units 15.00 15.05 Direct sale by Banco de Mexico 7,190 7,170 15.10 7,150 7,130 15.15 7,110 15.20 <--Mexican peso Dow Jones --> 7,090 7,070 15.25 7,050 08:30:00 a.m. 09:20:00 a.m. 10:10:00 a.m. 11:00:00 a.m. 11:50:00 a.m. 12:40:00 p.m. 01:30:00 p.m. 02:20:00 p.m. Source: Bloomberg. *values on inverse order. 26
Index 1. The FX market before the financial turmoil 2. What we did right/wrong 3. Structural change in the FX market 4. Final remarks 27
Final Remarks Full commitment to floating exchange rate regime In the short run intervention may still be needed but we favor the use of automatic mechanisms External position will not be compromised Sufficiency of international reserves Reduction of vulnerabilities Adequate risk management in banks and firms Reduction of information asymmetries 28
Recent developments in the Mexican Peso market March 2009 29