US President Donald Trump announced a discussion with Mexican President Claudia Sheinbaum, aiming to sign a trade deal within 90 days. Mexico will continue facing tariffs: 25% on fentanyl and cars, and 50% on steel, aluminium, and copper.
The USD/MXN exchange rate showed slight recovery, trading at 18.82, marking a 0.3% decrease on the day. This reaction occurred following the announcement of the trade talks.
Understanding Tariffs
Tariffs are levies on imported goods to favour local producers, distinct from taxes as they are collected at entry ports. Debate exists on their effectiveness, with some viewing them as protective measures, while others see potential for negative economic impact.
Trump plans to use tariffs to boost the US economy, focusing on imports from Mexico, China, and Canada, which together accounted for 42% of US imports in 2024. Mexico was the leading exporter with $466.6 billion. He aims to utilise tariff revenues to reduce personal income taxes.
Given the 90-day negotiation window, we see the recent dip in the USD/MXN to 18.82 as temporary relief rather than a new trend. The coming weeks will likely be defined by headline risk, creating significant volatility in the peso. We saw similar turbulence during the USMCA renegotiations back in 2018, when the peso experienced swings of over 10% based on political statements alone.
Impact on Markets and Strategies
This uncertainty suggests that long volatility strategies could be profitable. We are looking at elevated implied volatility in options on the iShares MSCI Mexico ETF (EWW) and the USD/MXN currency pair itself. After the VIMEX, Mexico’s volatility index, spiked over 30% following the June 2024 election results, we expect it to remain heightened and reactive to any news from the talks.
The specific threat of a 25% tariff on cars makes the auto sector particularly vulnerable. We are considering buying protective puts on automakers with heavy exposure to Mexican manufacturing. In 2024, Mexico exported over $130 billion in vehicles and parts to the U.S., so any disruption to this flow would immediately impact corporate earnings and stock prices for companies on both sides of the border.
Similarly, the proposed 50% tariff on metals creates a clear opportunity for a pair trade. We anticipate this will pressure Mexican steel producers like Ternium while benefiting their U.S. counterparts. Looking at data from 2024, Mexico was a top-five supplier of steel to the U.S., making this tariff a significant threat to their market share.
Beyond these specific sectors, the risk of a breakdown in talks could weigh on broader market sentiment. We remember the market pullbacks during the 2018-2019 trade disputes, which led to downturns in the S&P 500. For this reason, holding some out-of-the-money puts on major indices like the SPX could be a prudent hedge as the 90-day deadline approaches.
