- After rising on rate hike talk, monetary policy no longer drives the Canadian dollar
- Instead, the currency is succumbing to rising political risks thanks to NAFTA negotiations
- News that negotiations won't be resolved anytime soon is negative for the currency
With future rate hikes from the Bank of Canada looking more uncertain, the narrative of rising rates is no longer driving the Canadian dollar. Instead, the currency has been quite weak, in spite of recent strength in crude oil markets. This is especially true when compared to other commodity currencies such as the Australian dollar. Today, the threat of Trump ‘tearing up’ NAFTA is weighing on the Canadian dollar, despite the fact that Canada’s goods trade surplus with the US is limited compared to Mexico. While the US is operating a trade deficit against Canada in 2017, it enjoyed an overall trade surplus in 2016 thanks to strong services exports.
The White House and NAFTA
Trump’s decision to walk out of the Trans-Pacific Partnership, criticize the multilateral Iran nuclear deal and renegotiate NAFTA shows his aversion to multi-party agreements. Despite ongoing tensions over NAFTA, Trump has offered to negotiate a bilateral trade agreement directly with Canada. Given the small size of the trade deficit with Canada, this is hardly surprising. The real issue is the trade deficit with Mexico, which totaled $63.2b in 2016. A summary of the US goods trade balance with Canada and Mexico is highlighted below:
Canadian goods deficit narrows with falling crude oil prices
Prior to NAFTA, Canada and the US had signed the Canada-United States Free Trade Agreement in 1987. Given that the US and Canada’s economies complement each other well (the US excels in services and manufacturing, while Canada is a leader in natural resources), the deal made a lot of sense to both parties. Looking at Trump’s rhetoric, the real issue was the addition of Mexico to the agreement in 1994, at which point NAFTA superseded the Canada-United States Free Trade Agreement.
Political uncertainty to weigh on the currency
The latest news regarding NAFTA suggests that the talks may be extended into 2018. While each round of discussions is allocated five days today, a “source with direct knowledge of the talks” says that each round could be extended to seven or ten days. Schedulers are looking to book additional talks for February 2018. Trade negotiators had initially hoped to wrap up discussions by the end of 2017.
Looking at other currencies that are suffering from political uncertainties (such as the British pound), suggests that the Canadian dollar is likely to stay weak while NAFTA remains a risk. The Bank of Canada is also less likely to hike interest rates in 2017 with the overhang from trade negotiations in the background. Despite the fact that Canada is not the main target of the negotiations, the currency is likely to suffer nonetheless. The currency will be weighed down until there is more certainty of a positive outcome from the trade discussions, either through a new NAFTA agreement or from a direct bilateral agreement with the US.