The Mexican peso is among the strongest currencies in the world. It has outperformed its LATAM peers and global reserve currencies in recent years, even as Mexico’s growth has slowed and the economy lost momentum during the coronavirus pandemic. President Andrés Manuel Lopez Obrador has credited the peso’s strength to his government’s sound economic management and low debt levels. However, the real reason for the currency’s strength is the central bank’s monetary policy.

The Bank of Mexico raised interest rates seven times this year to counter inflation, which has been at a four-year high. That pushed the yield gap between the Mexican peso and the U.S. dollar to an eye-watering 6%, giving the peso an alluring carry trade opportunity. The Mexican peso is favored by investors seeking a higher return on investment than what they can get in their own country.

Another factor What’s driving the Mexican peso to be so strong? is its proximity to the United States, which attracts billions of dollars in commercial activity. The country’s location and its membership in the North American Free Trade Agreement (NAFTA) encourages foreign direct investment, which boosts exports. Its crude oil reserves contribute to international trade as well.

Last but not least, the strength of the peso has been boosted by rising remittances. The amount of money sent home by Mexicans working abroad rose by 13% to $53.1 billion in the first 11 months of the year. This has helped to drive domestic consumption, which in turn helps the Mexican economy.

However, all these factors will not keep the peso strong forever. As inflation expectations start to recede, the yield advantage of carrying pesos will disappear. A hawkish Fed is also likely to accelerate the pace of rate increases next year, which could prompt a gradual depreciation of the dollar against the Mexican peso.

Nevertheless, many analysts are bullish about the future of the Mexican peso. For example, market strategist Luciano Rostagno at Mizuho Bank expects the peso to reach 21 pesos per dollar this year and 22 pesos in 2023. But he warns that the stronger peso will have to contend with weaker international trade and slowing U.S. growth, which will affect demand for Mexico’s goods. Those risks, combined with the uncertainty of the 2024 presidential election, may prompt the peso to fall back.