A Negotiation or the Beginning of a Trade War: How Safe is NAFTA?Apr 5, 2018

Global trade conditions continue to deteriorate, as China recently announced tariffs of 25% on more than 100 US products in retaliation to US steel and aluminum product tariffs and the threat of additional US tariffs. The Trump administration has said it plans to invoke section 301 of the US Trade Act of 1974, which could significantly increase the number of products and trade subject to higher tariffs to the tune of US$60 billion.

With trade skirmishes opening up on multiple fronts, the US may feel increased pressure to get a NAFTA deal done ahead of this summer, when the Mexican presidential election and US mid-term election campaigning will be in full swing. Otherwise, the US risks attempting to win a war on multiple fronts, which tends to end badly if history is any guide.

The US recently dropped one of its more contentious demands that called for 50% of auto content to be made in the United States, which was a “non-starter” for the Canadian and Mexican auto industries. Perhaps this concession signals a desire by the US to get a deal done soon so the country can turn its attention to the real elephant in the room on trade, China.

Impact on Canadian economy

On the other hand, in the event NAFTA is killed, there is a probability that trade could revert to the 1989 US-Canada bilateral free trade deal, which shares similar trade rules with NAFTA in many areas. This possibility can’t be ruled out, as it seems Trump likes to negotiate bilaterally and has so far eschewed multi-lateral trade or other policies. The economic impact would be minimal in theory, but of course investment would be held back until more certainty emerges.

There is also a small probability that if NAFTA dies, trade would revert to World Trade Organization rules—under this agreement, tariffs on most products could rise to around 4%, although select products could have tariffs of 25% or more. The recent trade dispute between US-based Boeing and Canada-based Bombardier saw the Trump administration levy 300% tariffs. While these sizable tariffs were eventually struck down by US courts, they forced Bombardier’s C-Series plane into the arms of Airbus.

The bottom line is unpredictability often reigns with the current US administration. Trump’s personal negotiating style seems to favour creating chaos, often leading to changes that can be positioned as “wins” for his political base.

Impact on Canadian markets

Should NAFTA be removed, this could have a key negative impact on Canadian stock valuations and the Canadian dollar, at least initially. The market is currently pricing in a low probability of NAFTA being canceled, so investors who believe otherwise should consider raising the foreign component of their portfolios.

What’s next for NAFTA?

We think the consensus has it right that NAFTA will not be canceled outright. However, we do expect to see changes (maybe significant ones) so that a deal may be viewed as a win for the US president. In fact, a new agreement seems more likely, as the temperature has increased on China-US trade relations, the key for the US trade deficit. Trump has often cited the US stock market as a key metric of “success” for his administration, which we believe supports the view of changes as opposed to putting globalization fully into reverse.

Stephen Lingard’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.