The strength of the Mexican peso is such that investors are afraid to bet against it

Investors are taking the currency most expensive in the world to increasingly dizzying heights, ignoring the risks of interest rate cuts, divisive elections and analyst warnings.

The Mexican peso is the world’s best-performing major currency this year and the highest ranked on a list of real effective exchange rates—a measure of a nation’s competitiveness—compiled by Bloomberg. According to Deutsche Banksaid exchange rate is at the highest level that Mexico has recorded since at least 2005.

The rally has proven so relentless that investors are now afraid to bet against the currency, despite its high valuation. In fact, data from options markets shows that traders predict that a strengthening of the currency over the next three months is more likely than a fall.

“In the past, we’ve tried to go against that strength and it just hasn’t worked.“, said Nicolas Jaquierportfolio manager NinetyOne UK Limited in London, which is betting in favor of the currency. “It seems expensive in several models, but I think we should take them with caution”.

The keys to the peso’s strength have been its low volatility and the country’s record interest rates, which makes it attractive to borrow money in another currency and lend in pesos, or the so-called carry trade.

Getting higher and higher

After registering its largest annual appreciation in more than two decades last year, the peso has strengthened 1.8% against the dollar this year. It is now trading at around 16.69 per dollar, near its strongest level since 2015.

The progress comes despite the presidential elections to be held in June in Mexico and in USA in November, which—at least in the second case—pose the risk of abrupt policy changes. Some strategists are already urging caution.

Deutsche Bank analysts warned last week that valuations are “reaching extremes” and Bank of America described the peso as “overvalued”.

However, leveraged hedge funds are shrugging off those concerns and, as of March 5, had increased their net long contracts on the currency to their highest level since June, according to data from the Commodity Futures Trading Commission. (CFTC).

While Mexico’s central bank is expected to reduce its benchmark interest rate from 11.25% next week for the first time in three years, it will proceed at such a slow pace that it is unlikely to weaken the peso, according to Jaquier of NinetyOne.

Mexico currently has the highest real interest rates in Latin America and should continue to attract money managers, according to the chief investment officer of NWI Management Hari Hariharan. The high rates make it prohibitively expensive to bet against the currency.

“The peso will continue to be one of the favorite long positions of investors who finance by borrowing currencies such as the yuan, the euro and the Swiss franc. I don’t see that dynamic changing.“, said Hariharan. “There could be some volatility around the elections in both Mexico and the United States, but nothing serious.”

It is expected that Claudia Sheinbauma candidate backed by current President Andrés Manuel López Obrador, wins the June elections.

And although AMLOas the president is known, had disagreements with sectors of the country’s business elite, his fiscal austerity has become one of the anchors of the peso while investors observe growing deficits in emerging and developed markets.

The peso has also been supported by the record shipment of remittances from the United States, higher-than-expected economic growth and the prospect of more investments in the country by factories seeking to be closer to the United States.

“It’s practically a foregone conclusion that Sheinbaum will be a continuation of the status quo”said Christian Lawrence, a strategist at Rabobank in New York.

The US elections pose a greater risk to the peso and investors are likely to hedge their exposure to the peso as the vote approaches, he said.

Donald Trump’s victory in 2016 led to the peso’s biggest losses in more than two decades amid his threats to end a free trade agreement with Mexico and tax remittances. But in his bid to win back the White House, Trump is proposing tariffs on imports and escalating the trade war with China, which could drive more investment into Mexico.

“Mexico will not be singled out in the way it was last time, neither by Trump nor by the market.”said Dirk Willer, strategist at Citigroup. “The carry continues to dominate and the US elections are an afterthought that will become more forceful over time, but not in the coming months”.