MEXICO CITY/NEW YORK, June 29 (Reuters) - Mexican markets have rallied this month into a likely win by the leftist frontrunner in Mexico's presidential election on Sunday, but local assets could sell-off if a landslide victory for his party forms a congressional majority.
Ahead of the July 1 vote, Mexico's peso firmed to its strongest since late May in early trading Friday before reversing direction and sinking around 1 percent. Stocks rose to their highest in more than eight weeks.
Andres Manuel Lopez Obrador, a fierce critic of the ruling elite, held a wide margin in final polls. He would become Mexico's first left-leaning leader for decades if elected on Sunday.
Analysts said Lopez Obrador's economic team has been out in force to mollify investor concerns about a possible stark departure from pro-market policies or fiscal discipline. So far, markets are betting on moderate polices in line with Peru's Ollanta Humala or Brazil's Luiz Inacio Lula da Silva.
"His discourse has moderated and his economic advisors have been seeking a vote of confidence," said James Salazar, an analyst at CI Banco.
But bets in the options market suggest there could be big moves in the peso and stocks. One-month implied volatility , a gauge of expected near-term currency movement, has fallen from a spike earlier in June. But it remains at elevated levels seen back before the inauguration of U.S. President Donald Trump, who many worried could rip up the NAFTA free trade deal with Mexico and Canada his first day in office.
Karl Schamotta, a strategist at Cambridge Global Payments in Toronto, said the market had largely priced in a Lopez Obrador victory and was betting on moderate economic policies.
"There is an assumption that he is campaigning from the left and will govern further to the right," he said.
Some analysts said the end of uncertainty could help the peso post modest gains after a victory by Lopez Obrador, or AMLO as he is known. They said the currency could rally sharply if there was a surprise victory by either of his opponents, Ricardo Anaya from the right-left coalition or the ruling party's Jose Antonio Meade.
But they cautioned that the peso could tumble on fears of more radical policies if Lopez Obrador's National Regeneration Movement (MORENA) party gains a majority in Congress.
"An AMLO outperformance could lead to a sell-off of Mexican assets," said Nomura analyst Benito Berber.
Results of congressional races may not be clear early next week. But if Lopez Obrador wins more than 42 percent of the presidential vote, a MORENA majority looks much more likely, analysts said.
Schamotta said volatility levels suggest the peso could move between 3 percent and 5 percent, either way, if the election throws up an unexpected outcome, with a more muted move in the event of an expected Lopez Obrador victory.
Bets in the U.S. equity options market are slightly skewed toward potential losses in stocks, with more put options than calls in play, according to options analytics firm Trade Alert.
Open contracts on the $1.12 billion U.S.-listed iShares MSCI Mexico Capped ETF imply a roughly 4 percent swing in the shares, in either direction, by July 6.
"Net-net looks like positioning of late has a bearish bias," said Jim Strugger, derivatives strategist at MKM Partners in New York. (Reporting by Miguel Gutierrez in Mexico City and Saqib Iqbal Ahmed in New York. Writing by Michael O'Boyle; Editing by David Gregorio)