Trump or Clinton in White House: How the Mexican peso could be toast

Mexico's currency has been unusually volatile this year, and some attribute it to anti-Mexico and protectionist sentiment raised during this U.S. presidential election season.

"MXN (peso) is the currency most at risk from uncertainty and trade protectionism risks," Morgan Stanley strategist Hans Redeker said in a recent note.

The Mexican peso began under-performing other emerging markets earlier in the year when Republican presidential candidate Donald Trump started to talk more about deportations, ditching trade deals such as the North American Free Trade Agreement. There also was talk about having Mexico pay for a border wall by blocking money transfers, or so-called remittances.

However, this week the New York tycoon appears to be dialing back on some of his earlier hardline anti-immigration stances. He's no longer calling for mass deportations.

"The possibility of a Republican win in the U.S. elections is certainly a factor that triggers weakness of the Mexican peso," said Rafael Amiel, chief Latin American economist at IHS Global Insight. "Expect a lot of volatility because we don't know what will happen."

Amiel added, "Before, the U.S. elections were about immigration — and now immigration is second place in the agenda in the concerns or risk ranks. From the Mexican standpoint, the concern is NAFTA and whether the winner will revise the terms or the whole agreement."

Democratic candidate Hillary Clinton may also want to make changes in NAFTA, an agreement in force since 1994. Moreover, she has expressed concern about the Trans-Pacific Partnership, a free trade deal negotiated by the Obama administration. (Clinton supported it when she was secretary of state, calling it the "gold standard in free trade agreements.")

"It seems that both candidates would likely look to restrict trade to some extent," said Redeker. "Trump appears to be the more severe in this regard, proposing tariffs on key trade partners and leaving NAFTA unless there were meaningful concessions. Clinton hasn't suggested equally aggressive tactics but has also said she would renegotiate NAFTA."

The latest Reuters/Ipsos opinion poll out Tuesday shows Clinton up by 12 percentage points over Trump. Clinton starting moving higher in the polls in early August, around the time the Mexican peso started to strengthen.

"As soon as he (Trump) started to fade in early August, the peso started to come back," said Dirk Willer, head of emerging markets fixed income at Citigroup.

The peso's performance can also be driven by factors independent of the U.S.-Mexico story.

On Tuesday, the Mexican currency weakened when Standard & Poor's, the U.S. credit rating agency, downgraded the country's sovereign credit outlook to negative from stable, citing several concerns including low GDP growth. The peso slipped almost 1.5 percent at 18.5675 per U.S. dollar. Mexico's blue chip IPC stock fell 1.3 percent, marking its biggest daily slide in two months.

Amit Agrawal, an emerging markets strategist at Societe Generale, points out that about 75 percent to 80 percent of all Mexican exports go to the U.S. He said the peso moves are a reflection of Mexico's "high economic reliance on the U.S."

In the first half of 2016, Mexico ranked as the third-largest trading partner for the U.S. after Canada and China.

Trump has called NAFTA the "worst trade deal in history."

"The increased uncertainty can have an adverse effect on things like the peso and also on business deals between American firms and Mexican companies," said Robert Kleinhenz, an economist and executive director of research at Beacon Economics.

Yet, a way for investors in the emerging markets currencies to reduce U.S. election risks is to "short MXN as a hedge against a Trump victory," according a Citigroup note.

"In our view overall short MXN is the cleanest expression of a Trump trade," Citigroup said. "Even with the polls having turned against Trump recently, we think that the market is unwilling to fully give up on the Trump risk given that the Brexit experience is still all too fresh. As such Trump hedges may stay in demand going into November."