U.S. milking NAFTA negotiations as dispute drags on: should investors be concerned?

September 7, 2018 Ian Taylor

 

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The Trump administration proclaims that NAFTA was one of the worst trade deals ever made.

Its hard line on Canada in the negotiations continues to make headlines. Although the U.S. and Mexico have reached a tentative agreement, key sticking points remain between Canada and the U.S.

Talks are continuing, with all three countries saying they are confident a deal can be reached sooner rather than later.

So, what does the uncertainty around NAFTA negotiations mean for the Canadian market—and for your portfolio?

Canada is not budging on certain points

Key sticking points for Canada include support for agriculture (specifically, supply management in the dairy and poultry industry), tougher rules for copyright and intellectual property on websites, and the maintenance of a binding mechanism for settling trade disputes. The U.S. especially wants Canada to open up its protected dairy market and end the system of supply management that protects Canada’s industry.

Both Prime Minister Justin Trudeau and Foreign Affairs Minister Chrystia Freeland have said that Canada will not sign a bad deal (reading between the lines: a deal that’s politically unpopular with Canadians). It’s therefore unlikely that Canada will give in on these points easily.

Possible outcomes for the negotiations

Canada and the U.S. could come to an agreement based on the deal negotiated between the U.S. and Mexico. If they do, expectations will be for the Bank of Canada to resume raising interest rates to keep inflation in check given the end of economic uncertainty caused by trade tensions.

The short-term impact of a deal may then be for the Canadian dollar to strengthen modestly—because expectations of higher interest rates will make it more attractive for people to hold Canadian dollars—and for bond yields to rise slightly, in line with interest rates.

However, even if all three countries come to an agreement, it may take months to get any certainty about the deal closing, as they will need to formally ratify the agreement. With U.S. midterm elections fast approaching and some uncertainty over whether U.S. Congress will support the revisions, an agreement may be easier said (or tweeted) than done.

It’s trickier to assess the impact of a failed negotiation. There may be increased uncertainty relative to today, which could weigh on markets and on the Canadian dollar in the very short term. More likely, negotiations would continue to drag on.

The U.S. could threaten to walk away from U.S.–Canada trade agreement via Article 2205 of the NAFTA agreement, triggering a six-month timeline for an exit. As we have seen, the Trump administration is not shy about using all the tools at its disposal to strengthen its hand in negotiations. For example, it has already labelled Canada a national security threat to the U.S. in imposing steel tariffs.

At the same time, Congress may require Canada to be part of any new deal, which could prevent an agreement with Mexico from passing even if achieved through negotiations. All of this would extend the period of uncertainty.

Are NAFTA negotiations having a negative impact on the Canadian economy and market?

While September has generally been a volatile month for equities historically, there are limited signs that the negotiations are affecting business investment and growth in Canada.

The Canadian economy is running close to full potential, which is not what you would expect if negative sentiment towards NAFTA were having an impact. The Bank of Canada has raised interest rates twice this year, and markets are expecting an additional hike at its next meeting in October.

The noise created by seasonal volatility is just that—noise. We expect equities to continue to do well over the coming months. Earnings have been very strong globally and in the U.S. in particular; this trend is likely to continue.

Despite the heated trade rhetoric, there is only a low probability of a global recession. Plus, the recent major fiscal stimulus in the U.S. and ongoing low interest rates continue to support its economy. While inflation has risen, it remains contained, and there is no expectation of it spiralling significantly higher.

From a tactical perspective, we continue to maintain a lower-than-benchmark allocation to Canadian equities. This is primarily because of our expectation for better performance out of the U.S. and international markets that offer more cyclical stocks (typically from companies selling discretionary items that consumers can afford to buy in good economic times).

Ignore the politics and stay invested

At MD, the shortest time frame we operate within is a 12-month view. While the U.S. midterms and NAFTA negotiations dominate the current headlines, they will eventually recede from the headlines, only to be replaced by the next politically hot topic. It is our view that trying to time markets based on inherently uncertain political agendas is a losing strategy.

For most investors, the impact of these events is far less important than what is going on in the broader global economy, and that remains our focus. The good news is that the fundamental backdrop remains a positive one for developed equity markets.

If you have any questions about how NAFTA negotiations may affect your portfolio, please contact your MD Advisor. 

 

About the Author

Ian Taylor

Ian Taylor, CFA, CIM, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees strategic and tactical asset allocation mandates, alternative investment mutual funds and is a member of MD’s Tactical and Risk Allocation Committee.

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