June's USD/MXN rally was driven by three key factors. We'll consider them in more detail below, but first let's start with the main reason for the rally.
Recent oil data from Saudi Arabia is a catalyst for the rally. Oil prices are driven by several important factors, including demand and supply. In general, the supply-demand balance determines oil prices. When the supply is high and demand is low, oil prices go up.
The commodity that has historically driven the USD was gold, and lately, this has been declining as well. In the past, when the USD weak and gold was rising, the USD strengthened, so we might expect a similar pattern to repeat in this regard.
The Federal Reserve has added to the USD's strength by raising interest rates for the first time in six years. This has pushed the USD even further, strengthening it even more. This is what drove the rally as well.
One other important thing about the rally is recent oil data from Saudi Arabia. This data was seen as highly negative, but we saw an upside break on the USD/JPY and USD/CHF pair and some support at $91.70. This helps to support the USD in the near term. Recent crude oil data from Saudi Arabia is typically very strong.
A "big dollar" is really "a big dollar with a bad economy." What happens when we see a rebound in the USD and a weak dollar? Well, we are likely to see a currency trade to either the downside or upside of its true strength, depending on the ultimate direction of our economic outlook.
In short, we should be looking for a lower rate of inflation. We'll look at this in more detail below. However, if there is going to be an uptrend in the currency, then the USD/MXN will continue to test the June high and we should expect it to end the month either over the June high or a bit under.
Another reason that makes the rally all the more attractive is that the currency has continued to strengthen against the US Dollar. We would expect the dollar to weaken further in an economic down cycle, but things are different this time. The US economy has been slow to recover from the financial crisis and this has been reflected in US economic data like manufacturing output and retail sales.
This means that inflation hasn't moved up, which is a problem. An advantage for the currency would be if it weakens even further and the economy doesn't bounce back. If that happens, then the USD would gain even more strength against the currencies of other major economies.
The way to determine whether the USD would rally or decline in a move towards a lower dollar versus a weaker currency is to watch for any signs of inflation and any reduction in the FX deficit. Let's review some examples where currency strength has been important.
A good example is during the Long Run period, where it's critical to make sure that the two currencies trade together, not to make an adjustment. During that period, it is also important to watch for signs of deflation is often a sign of a weak currency.
The best time to invest is during the Long Run period. We've seen this in history. where currency pairs to trade together, especially during downtrends.