This trade will tell you whether Trump won debate

Published Mon, Sep 26 20162:38 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Hedge funds may not like Donald Trump , but that doesn't mean they won't try to make some money off him. Investors are building a big short in the Mexican peso, which has become somewhat of a poster child for the unconventional Republican candidate's anti-trade and anti-immigration stances. Ahead of the first debate between Hillary Clinton and Trump, the peso was trading close to the record lows set last week. Investors in the futures market have been building what is likely now to be the biggest short position ever in the currency. "The peso has been beaten down like a pinata ever since he's started showing some strength. The peso has been the primary expression of emerging markets nervousness about Trump coming to power," said Boris Schlossberg, managing director, foreign exchange strategy at BK Asset Management. Last Wednesday's 19.9130 was the record low for the peso against the dollar. Here's what to expect if the pair cracks the psychological level of 20. That type of breakout move in the near term could signal that Trump won the debate. If Clinton pulls significantly ahead after Monday night, that could send the peso into a sharp reversal. Using Kensho, CNBC PRO found a clear correlation between Trump's probability and the reaction in both the Mexican peso and the MSCI Mexico ETF . In six instances where Trump's probability jumped since April, the peso was down an average 1.2 percent five days later, and the iShares MSCI Mexico ETF fell 0.9 percent. Currency strategists agree the one asset that has seen the most damage from Trump has been the peso, due to his negative views on immigration, his plans to build a wall between the U.S. southern border and Mexico, and his constant comments about the shortcomings of NAFTA. Since Trump met with Mexican President Enrique Pena Nieto at the beginning of September, the futures market's short peso position has doubled. Citigroup strategists expect the peso to jump to 22-23 if Trump looks likely to win the election. But they also expect Mexico to take a double-barreled approach to defend the currency. They expect there will be an out-of-consensus 75 basis point interest rate hike Thursday by Banco de Mexico as well as multiple interventions. But JPMorgan strategists disagree. They expect to see the central bank stay on hold and hike alongside the Fed in December. "We expect Mexico to tighten fiscal policy significantly next year, which should ease concerns about a potential deterioration in debt dynamics, the budget deficit, the current account deficit and inflation. Furthermore, both headline and core inflation are still trailing at or below the 3 percent mandate. Banxico also gained breathing room from the Fed's decision this week to remain on hold. Finally, the U.S. election outlook calls for caution, as it could either weigh on the currency or, quite the contrary, elicit a stronger peso," wrote the strategists. While Citigroup analysts expect to see higher rates from the Banco de Mexico, they do not see the peso reviving ahead of the Nov. 8 election, unless Trump begins to seriously lag. Citigroup expects Clinton to win, and if she does, they expect the peso would then quickly reverse its decline. "Thus, we have raised our 0-3 and 6-12 months forecast to 18.9 and 18.5 from the previous 18.5 and 18.9 respectively. The updated forecasts imply a year-end estimate of 18.8," the Citi strategists wrote. As for the central bank, they expect it to try to break the currency's fall with a strong shot of policy because smaller hikes won't be enough, given the correlations and the "misalignment" in the market. They noted that the peso's depreciation against the dollar of 5.1 percent so far this month is the largest among major currencies. The second worst is the British pound, at 1.3 percent. "Banxico's board is certainly going to have an intense discussion, which will probably involve actions beyond the rate realm and with an emphasis on market operation rather than on the traditional macroeconomic factors," they wrote. Brown Brothers Harriman chief FX strategist Marc Chandler said there are other reasons the peso is falling. "There's good fundamental reasons leaving aside Trump — oil prices, incompetent government and emerging markets in general," he said. "They lost a finance minister over Trump business," Chandler said. The former Mexican finance minister, Luis Videgaray, stepped down after the meeting he promoted between Trump and Pena Nieto backfired. The move was seen as unpopular locally and Trump and the Mexican president painted different versions of what transpired, including whether Trump's idea of building a wall was discussed or who would pay for it. Pena Nieto said he told Trump Mexico would not pay. Since that meeting on Sept. 1, there's been a surge in short positioning in the peso. "There's been a huge build-up of short peso positions in the futures market," said Chandler. He said the gross short position jumped by 24,000 contracts in the week ending last Tuesday, to a total 109,000 contracts reported by the CFTC. The record was 111,000 in July, and the latest week has likely seen that surpassed, he said. At the end of August, there were just 53,000, he said. "Speculators doubled gross short peso futures positions in the last three CFTC reporting weeks," he said. "The futures position is the tail of the dog, but I use it as a proxy for speculators, momentum traders and trend followers."

US presidential candidate Donald Trump (R) and Mexican President Enrique Pena Nieto prepare to deliver a joint press conference in Mexico City on August 31, 2016.

Yuri Cortz | AFP | Getty Images

Ahead of the first debate between Hillary Clinton and Trump, the peso was trading close to the record lows set last week. Investors in the futures market have been building what is likely now to be the biggest short position ever in the currency.

"The peso has been beaten down like a pinata ever since he's started showing some strength. The peso has been the primary expression of emerging markets nervousness about Trump coming to power," said Boris Schlossberg, managing director, foreign exchange strategy at BK Asset Management.

Last Wednesday's 19.9130 was the record low for the peso against the dollar. Here's what to expect if the pair cracks the psychological level of 20.