The trade relationship between the U.S. and Mexico, America's top trading partner in 2023, entered a new phase of tension.

President-elect Donald Trump's recent pledge to impose 25% tariffs on all imports from Mexico and Canada, as soon as he returns to the Oval Office in January, has sent ripples through currency markets and put significant downward pressure on both the Mexican peso (MXN) and Canadian dollar (CAD).

The Mexican currency weakened to levels last seen in August 2022, with the USD/MXN exchange rate eyeing the sixth week of gains in the last seven in response to escalating trade concerns.

Market jitters were amplified by Mexico's potential retaliatory measures, which could disrupt the deeply interconnected economies of both nations.

The risk of a U.S.–Mexico trade war could jeopardize nearly $800 billion in annual trade flows.

Mexican Peso Takes a Hit

According to Alejandro Cuadrado, BBVA’s chief strategist, the peso was particularly vulnerable on Tuesday, with USD/MXN breaking through key resistance at 20.60 and testing 20.80, a level last seen after the 2020 U.S. presidential election.

Cuadrado highlighted the sell-off reflects the uncertainty surrounding U.S. trade policy and Mexico's potential retaliation, with risks of further depreciation looming.

"The break of USD/MXN 20.60 has opened the room towards the 21 handle," Cuadrado said, adding that investors are now awaiting more policy clarity.

He warned that the MXN could face significant headwinds in the short term, especially if U.S. tariff threats materialize.

“Tuesday's sell-off was also a reminder that risks can awaken suddenly and rapidly given the uncertainty, erratic communication, lack of definition and overall style of policymaking,” Cuadrado added.

Trade War Threat Looms About $800 Billion In Bilateral Trade

Mexico surpassed China to become the U.S’s largest trading partner in 2023, underscoring the critical importance of the relationship.

According to official U.S. Census Bureau data, total goods and services traded between the U.S. and Mexico reached $798 billion last year.

This figure reflects the deep integration of their economies under the United States–Mexico–Canada Agreement (USMCA), which replaced NAFTA in 2020.

Here's a breakdown of 2023 U.S.–Mexico trade:

• U.S. Exports to Mexico: $322 billion
  • Mexico is a key buyer of U.S.-produced goods, including motor vehicle parts, semiconductors, basic chemicals, petroleum products and agricultural commodities.
  • In energy, Mexico is the largest importer of U.S. natural gas and petroleum products.
  • U.S. goods exports to Mexico have grown exponentially from $42 billion in 1993 (pre-NAFTA) to $322 billion in 2023.
• U.S. Imports from Mexico: $477 billion
  • Nearly 80% of Mexico's total exports are destined for the U.S..
  • Top categories include automobiles ($130 billion), electronic equipment ($85.6 billion), and machinery and reactors ($81 billion).
• U.S. Trade Deficit with Mexico: $152.5 billion
  • The 2023 trade deficit with Mexico is nearly three times larger than a decade ago, reflecting the country's growing role as a manufacturing hub for U.S.-bound goods.

Automotive Industry At The Center Of Trade Tensions

The U.S. auto sector is particularly vulnerable to trade disruptions with Mexico. Of the $477 billion in U.S. imports from Mexico in 2023, vehicles accounted for $130 billion — by far the largest single category.

Automakers such as General Motors Co. GM, Ford Motor Co. F, Stellantis N.V. STLA, Volkswagen AG VLKAF, Toyota Motor Corp. TM, and Honda Motor Co. Ltd. HMC have long relied on Mexican factories for their affordability and proximity to U.S. markets.

Components for cars, such as engines, transmissions and interior electronics, often cross the U.S.-Mexico border multiple times before final assembly.

Additionally, the Wall Street Journal published on Tuesday that Chinese electric vehicle manufacturer BYD — a major rival of Tesla Inc. TSLA — is in the final stages of planning a factory in Mexico — a move that could further heighten trade tensions between the two neighbors.

The Wall Street Journal also reported Mexican officials are concerned a BYD factory could send the wrong signal to Trump and his trade-focused allies, potentially implying Mexico aims to serve as a backdoor for Chinese companies to access the U.S. market.

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