Mexico is now number one in trade volume with the US.

The pandemic of 2020 invariably changed aspects of the global economy. Many economic systems reverted to pre-pandemic conditions, but not without COVID-era measures and restrictions leaving their mark. Namely, the worst disruptions in global supply chains seen in decades. 

Global Supply Chains Disrupted by Pandemic

The last thirty years have been described as the “era of globalization,” as trade expanded and countries became more reliant on each other for the seamless transfer of essential goods. However, the cessation of normal conditions led to supply chain bottlenecks that affected industries worldwide. Shortages of key goods, such as microchips, led many companies to slow or halt production. The ensuing scarcity of many end products contributed to the huge spike in global inflation.

Nearshoring

Amidst the supply chain collapse, many companies were forced to consider alternatives to existing sources. China reliably provided needed goods for over 30 years, but the sudden disruption caused foreign countries, particularly the US, to find alternate sources of requisite goods. Many American companies expanded their footprint in Mexico, and foreign direct investment (FDI) rose substantially. In the first quarter of 2023, FDI in Mexico totaled $18.64 billion with over 56% coming from the US. Investment from the US has been facilitated by the USMCA agreement, a replacement to NAFTA implemented in 2020. Manufacturers of vehicles, electronic components, and auto parts were among the biggest recipients of foreign investment.

Strong Peso

The Mexican peso has been one of the strongest currencies in the world, appreciating by over 19% against the dollar since Mexico started raising rates in June 2022. The driving factors are:

• High interest rates: Mexico raised short-term interest rates to 11.25%. This produced a wave of speculative buying for better returns (US rates are currently at 5.5%) and provided carry-trade opportunities (borrowing in a low-interest rate currency and lending in one with higher rates).
• FDI: As mentioned above, there has been an enormous increase in money flowing into Mexico as companies seek to nearshore production.
• Strong economy: Mexico’s economy has recovered its employment and Gross Domestic Product (GDP) back to pre-pandemic levels. Growth is expected to stay at 3% in 2023, continuing the pace of 2022.

What’s next?

• Economists expect nearshoring to increase over the next few years as more companies build manufacturing facilities in Mexico. This will drive further growth in US-Mexico trade.
• The peso will likely weaken against the dollar from current levels. Mexico’s inflation rate has dropped to 5.06%, which should allow the central bank (Banxico) to lower interest rates. Experts predict that monetary easing will begin in late 2023 or early 2024.
• The course of the Mexican economy may be largely driven by its neighbor to the North. If the US economy avoids a prolonged recession, the current investment trend will continue supporting the growth of Mexican industry.

Takeaways:

• Recent growth in US-Mexico trade has pushed Mexico past China and Canada as the US’s top trading partner. The deterioration of relations between the US and China may add momentum to the shift to Mexico.
• A weaker peso should accelerate nearshoring investment in Mexico. Markets will be paying close attention to the next Banxico monetary policy meeting on August 10 for indications of what to expect in the future.
• Though Mexico is expected to lower interest rates, its rates will still be significantly higher than the US. This could keep the peso at elevated levels against the dollar for the next several years.
• The peso will most likely be volatile on forex markets over the next few quarters, which will inevitably lead to increases in foreign currency risk for companies doing business between the US and Mexico. 

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