Mexico is turning innovative in its bid to fight the slumping peso.

Late on Tuesday, the country’s central bank surprised markets by unveiling a $20bn currency hedging programme that would allow policymakers to combat volatility in the peso without dipping into their foreign exchange reserves.

The announcement has helped keep the peso at a three-month high at MXN19.7040 per dollar – its strongest level since the first day after Donald Trump’s election on November 9. It had slumped to an all-time low of 21.95 against the dollar in January.

Banxico’s programme will involve auctioning US dollar hedges, with the scheme kicking off with a $1bn auction taking on March 6.

Chris Turner, head of FX strategy at ING, thinks it is a case of “desperate times and desperate measures”, noting that the move has echoes of that carried out by Brazil’s central bank in 2015.

Gustavo Rangel, chief Latin American economist at ING, says the hedging programme could give the central bank some room to pause on its latest interest rate hike cycle – after carrying out six consecutive rate rises over the last six months.

But the Dutch bank is staying bearish on the peso in the wake of Mr Trump’s protectionist vows to rip up the North American Free Trade Agreement:

Even though this hedge scheme will not impact Banxico’s FX reserves figures, questions will still be asked whether it is large enough to offer protection for the $230bn of portfolio capital or $500bn of FDI in Mexico.

Equally, as Brazil discovered, these programmes come at a fiscal cost. MXN briefly traded under 20 on the news, but with higher US rates, a potential border tax adjustment and NAFTA renegotiation on the horizon, we remain bearish MXN.

Jason Daw at Société Générale notes that the size of the hedging programme is “relatively small” as the peso is the most traded emerging market currency outside the Chinese renminbi.

“By comparison, the Brazil FX swap program reached a peak of $116bn outstanding in early 2015 with the current short dollar position outstanding being $26bn”, says Mr Daw.

Still, the move is enough for Soc Gen to close its recommendation of going “long” on the dollar against the peso at around MXN 20.01. Mr Daw adds:

For USD-MXN to regain its previous highs might require either a) an intensification of hostilities toward Mexico on the trade front or b) more aggressive Fed action than currently priced in.

Andres Abadia, senior economist at Pantheon, thinks the peso is undervalued despite its 9 per cent rise since January. But the current bout of weakness could still have further to run:

We don’t expect the MXN to collapse, though, because we anticipate a soft Nafta renegotiation, which will have with a limited effect on Mexico’s economy.

At the same time Banxico action, such as yesterday’s announcement that it will offer as much as $20bn in foreign exchange hedges to support the MXN without bleeding international reserves, suggest that pressures on the currency will remain in check in the near-term.

Chart courtesy of Bloomberg

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