The Mexican central bank (Banxico) surprised financial markets on Wednesday by hiking the monetary policy rate by 50bps at an unscheduled policy meeting.In addition, the country's Exchange Commission announced the suspension of the current intervention mechanism (which foresaw daily interventions of up to USD 400m). Instead, the Commission will now intervene at its discretion to support the currency, which they started to do this week as well. UBS analyst teams believes MXN rally is not necessarily sustainable and they are leaving the forecasts for USD/MXN unchanged for the time being. Key Quotes “The size of the overall program is unclear and the magnitude of interventions was not released, but the joint efforts by Banxico and the Commission were significant drivers behind Wednesday's appreciation of the peso. The MXN rallied roughly 3% versus the USD and continued to extend gains”. “We welcome the change in the intervention mechanism as we think a discretionary approach allows the Commission to react more flexibly and tactically to market conditions than under the previous framework. Wednesday’s interventions occurred in an environment of low liquidity and trading activity and were therefore a more efficient and sustainable use of FX reserves than the previous, more mechanical approach, we think.” “The rally in MXN has likely squeezed out existing short positions and the policy rate hike has increased hedging costs and the interest rate carry. These factors are positive for the peso. On the other hand, the factors that have troubled the peso in recent quarters are still here: Low energy prices, subdued growth, and worries about the global economy and Latin America specifically. Although energy prices rallied in recent days, fueled by discussions between OPEC and non-OPEC countries about output freezes, we note that the supply overhang will likely remain a challenge for prices in 1H16.” “Weaker growth in the US - although we think current recession fears are overblown - the need for further fiscal tightening in Mexico due to low energy prices and higher interest rates all weigh on growth dynamics in the country. International investors might continue to use MXN as a proxy currency to hedge risks in Latin America and in emerging markets more broadly. Hedging costs are still considerably lower than in Brazil, for example, which suggests that MXN remains sensitive to negative news flow out of the region.” “While our near-term target of USDMXN 20 looks more conservative now, we think the recent rally is not necessarily sustainable and are leaving the forecasts unchanged for the time being. In addition, we would not be surprised to see fresh market attempts to push MXN higher. While the Exchange Commission can engage in further discretionary interventions, Banxico would likely think twice before tightening monetary policy conditions further in an environment of low growth domestically.” “We are therefore also keeping a short position in MXN versus the Russian ruble in our EM FX strategy. Although MXN rallied in recent days, the upside on RUB was even higher. We would change our near-term forecast on growing evidence for a more sustainable increase in energy prices or a re-pricing of global recession fears. Over the medium to longer term, we see USDMXN at around 18.50.” For more information, read our latest forex news.