Mexico to offer up to USD$20 billion in forex hedges to aid battered peso

Mexico's top finance policymakers said on Tuesday the central bank will offer up to USD$20bn in currency hedges, a major shift in policy aimed at helping Latin America's No. 2 economy tame volatility that has battered the peso.

The move puts Mexico, which has been one of the most orthodox supporters of free-floating exchange rates, more in line with other emerging market central banks such as Brazil's, which use derivatives to support their currencies.

"This is the most important change in the approach to FX policy since the Tequila Crisis," said Marco Oviedo, an economist at Barclays in Mexico City, referring to the economic crisis that pushed Mexico to adopt a free-floating peso in December 1994.

"This is not a fixed exchange rate, but it definitely has an important impact on the level of the exchange rate," Oviedo said.

Mexico's peso surged 1.8 percent on the news, briefly breaking the psychological level of MX$20 per dollar for the first time since Donald Trump's surprise November U.S. election victory. The currency has fallen to record lows since last year, deepening losses after Trump's win due to his threats to impose trade barriers on U.S.-bound Mexican goods.

"In the last months, the peso exchange rate against the U.S. dollar has shown high volatility that is not consistent with the country's economic fundamentals," Mexico's foreign exchange commission said in a statement.

The commission, which is made up of top officials from the central bank and finance ministry said the program will not use the bank's international reserves, but instead will auction contracts similar to non-deliverable forwards that pay in pesos. The commission said the first auction of the new instruments will be on March 6 for up to USD$1 billion. The terms of the contracts will not be more than 12 months.

Mexico's central bank has hiked interest rates by 325 basis points since last year in a bid to support the peso and many analysts had been calling for stronger measures.

"Some people are asking why now and not when the peso was under pressure. Are they worried about flows going forward or did they think it was just a good moment to do it?" said Ernesto Revilla, an economist at Banamex.

Revilla noted the bank had previously sought to intervene at moments when the peso was gaining against the dollar in order to maximize the impact of announcements.

During 2015, Mexico relied on dollar auctions to prop up its peso after a global oil price drop, but it abandoned the program in February 2016 after burning through billions in reserves.

The central bank directly entered the market to sell dollars on two occasions since last February and analysts at Goldman Sachs warned last month that Mexico had limited firepower to keep defending the peso with such sales.