USD/MXN surges to near 17.00 on market caution, focus on Middle East conflict

• USD/MXN improves as the US Dollar receives upward support from risk-off sentiment.
• Fed’s Bostic said that inflation deceleration toward the 2.0% target could slow down.
• Banxico’s officials face challenges in reducing interest rates due to high inflation.

USD/MXN moves upward for the second straight day, trading higher around 17.00 during Tuesday’s European session. Traders are favoring the US Dollar following hawkish remarks made by Atlanta Federal Reserve (Fed) President Raphael Bostic. Bostic suggested the possibility of inflation fluctuating if policymakers decide to cut interest rates prematurely, thereby providing support to the USD/MXN pair. He also cautioned that the deceleration of inflation toward the Fed's 2.0% target was anticipated to slow down in the coming months.

Additionally, the Middle East region is experiencing heightened caution in the market due to the escalating Israel-Gaza conflict. The Iranian Islamic Revolutionary Guard Corps (IRGC) targeted northern Iraq near the US Consulate in Erbil, adding to the geopolitical tensions. On Friday, the US-led Combined Maritime Forces (CMF) issued a warning, advising all ships to avoid the Bab al-Mandab Strait. This has led maritime vessels to alter their routes away from the Red Sea in response to attacks by Yemen's Houthi movement.

The recent economic data from Mexico indicates that the country is grappling with challenges. The annual inflation rate increased from 4.32% to 4.66% in December. Although the headline inflation has eased to 5.0%, it remains elevated. This high inflation rate could potentially dissuade officials of the Bank of Mexico (Banxico) from implementing policy-easing measures in the first quarter of 2024.

Market participants are expected to closely monitor Mexico's Retail Sales data on Friday for additional insights into the country's economic landscape. Additionally, on the United States docket, the US NY Empire State Manufacturing Index for January is scheduled for release on Tuesday, along with a speech by Federal Reserve official Christopher J. Waller.