(Bloomberg) -- For all the concern that the U.S. might dump Nafta or that Mexico’s next president could upend economic policy, the peso is forecast to be the world’s best-performing major currency in the first half of 2018.
True, the expected gain is due in no small part to how much it sank at the end of last year. The peso tumbled to a nine-month low against the dollar on Dec. 26, capping a four-month decline fueled by worries Donald Trump will pull out of the trade agreement with Mexico and Canada, and that Andres Manuel Lopez Obrador could win election in July. The peso lost a third of its value during the past four years, when it was the worst performer among the world’s most-traded currencies.
Yet the forecast also reflects Mexico’s growth potential, stronger fiscal position and narrowing current account deficit, particularly as the year wears on, said Ernesto Revilla, who heads Latin America economics at Citigroup Inc (NYSE:C). His bank expects the peso to rally more than 5 percent during the next six months to a year, and to reach 17 per dollar -- 14 percent stronger -- beyond a year, or in the "long term."
"There definitely has been some overshooting, not explained by fundamentals, but explained by overall emerging-market behavior and some concerns of Nafta and the election," said Revilla, a former chief economist at Mexico’s Finance Ministry. "The Mexican peso still looks cheap relative to its long-term value."
The peso rose 0.4 percent at 11:20 A.M. in New York, extending a four-day winning streak.
While the top forecasters tracked by Bloomberg universally expect the peso to strengthen, some investors may hesitate to buy pesos until it’s clear that risks have dissipated. Alejo Czerwonko, an analyst at UBS AG, expects the peso to appreciate modestly to 19 per dollar by the end of June and close at that level at the year’s end. With the peso’s high carry -- the interest paid to investors holding the currency -- that’s a solid bet, but he says he still wouldn’t recommend the currency.
"There are more interesting opportunities out there in the emerging world," Czerwonko said. "The market is currently partially but not fully pricing in a failure of Nafta or a Lopez Obrador presidency, which means that if either one were to materialize, we would expect a weaker trend for the peso."
Analysts on average expect the peso to strengthen 1.9 percent in the first half of the year, according to the median forecast of analysts surveyed by Bloomberg. While that may not seem like much, it’s enough to be the most among 16 major currencies tracked by Bloomberg. Thirteen are forecast to weaken.
Citigroup’s analysis includes the real effective exchange rate -- the purchasing power adjusted for inflation -- tracked by the Bank for International Settlements, Revilla said. Mexico’s currency is among the most undervalued by that measure when compared with its long-term average.
The bank’s peso forecast assumes "macroeconomic stability" and "continued implementation of economic reforms," Revilla said. If the presidential winner takes a different policy path, Citigroup could reconsider its projections.
(Updates to add peso’s performance today in fifth paragraph.)