U.S. protectionism is impacting Canadian markets and businesses because rhetoric is now being followed up with action. Brittany Baumann, Macro Strategist, TD Securities, talks to Sara D’Elia about the risk of a full-blown trade war, NAFTA timelines, and what could happen at the Bank of Canada’s July interest rate decision.
Glad to be back.
So I want to kick things off by asking you about what we heard today, and really does this change the forecast for July? Because a couple of weeks ago, the market was pricing in an 80% chance of a rate hike. Now, it's a bit of a coin toss. Is that the right way to characterize it?
And it still is. This was a highly-anticipated speech in this backdrop. The main drivers behind this reduction and the market odds for a July hike were or two things. First being an escalation in the trade risk recently, and then secondly, we have had some disappointment in recent data releases. What we heard today didn't really provide us much clarity going forward given it is a coin toss for July, really it could have gone either way. But what we're left with is what we feared, in that we're still scratching our heads here in terms of what this means for a July hike.
The speech itself, I think, didn't contain a lot of new information. On the one hand, he did acknowledge that the May statement was an affirmation of greater confidence in the outlook. But on the other hand, he is still assessing the recent steel and aluminum tariffs that have actually been implemented, the ongoing adjustment in the housing market. And so how that impacts the outlook, we'll have to wait and see for the July meeting.
What we saw in the press conference, though, was a bit more upbeat tone, almost downplaying the negative impact of trade uncertainty. So I think that's important, because right now it's a bit uncertain how the Bank of Canada actually reacts to that going forward, in terms are what are the delay rate hikes. So what we're left with right now is that we still think he's keeping the door open to July, but we are going to have to wait for some more data.
And I want to switch gears a little bit, because that wait-and-see tone has also been driving equity markets as of recently. There's been a bit of volatility in the markets, largely driven by the fact that we've moved from just tough talks around trade to some real action. How do you think this has impacted the risk of a full-blown trade war?
So I think the concern is exactly that, that the rhetoric is now being followed up by action, in terms of what President Trump has done so far in regards to Canada. He has now implemented steel and aluminum tariffs. Canada was initially given an exemption of that. These are on national security grounds. So this is not a strong case to impose such measures on Canada. We find that it's really largely linked to NAFTA progress. US wasn't seeing enough of it. So they imposed these tariffs somewhat as leverage for the process going forward.
So in terms of why we are more concerned is that companies themselves, in response to future threats of tariffs, will have to take them more seriously. So this could have more and more economic impacts down the road. And then also, of course, raises the risk of not only trade wars, in that countries will have to retaliate, but that he might actually act with more tariffs targeting more and more products, which of course, therefore, has macroeconomic impacts.
You touched on the impact this is having in terms of sentiment on both businesses and even potentially the Canadian economy. So what do you think this could mean for NAFTA timelines?
In terms of the implications for NAFTA, I think the main thing is that the timeline is now going to be extended. Otherwise, our views remain unchanged, and we've held the view for some time that we eventually will get a deal. But talks are just likely to drag on, and now it looks likely that they'll drag on until next year, as opposed to something being finalized by the end of the year. But in terms of the adverse consequences that we're most worried about, NAFTA termination or the triggering of Article 2205, which is the Notice of Termination, those are still a tail risk. And I think the US still very much wants a deal, perhaps preferably before the US midterms, but I think now that we're going to have talks dragging into the summer.
After the Mexican elections, I think the Mexican election outcome itself does introduce some political risk mainly that it might be hard to strike a deal before the Mexican Congress and new president formally start in the fall. So right now, going forward, I think what Trump has done is he is trying to gather up more leverage for NAFTA talks. So what we really want to watch for is whether this does induce concessions out of Canada and Mexico, because I think that is really what's needed for a NAFTA resolution going forward.
To sum things up, tell us a little bit about what you think this could mean for the Canadian dollar as well.
So at this stage, we're still holding a near-term bearish view for the Canadian dollar, and this is really upon the escalation of trade risks. Specifically now on tariffs, not just NAFTA uncertainty, there is somewhat of a premium in dollar CAD at this stage, not significant. So there's still a lot of negative risks that are still unpriced in our view, but it's enough to keep the Canadian dollar probably above $1.30 in dollar CAD terms through the summer.
And one of the new threats now to Canada is the imposition of auto tariffs. This would have a significant negative impact on the Canadian economy as a whole, given that auto trade is such a significant share of the US-Canada bilateral trade. So that kind of uncertainty, in regards to future tariffs hanging over our heads, that is also something that is going to weigh on the currency going forward, regardless of whether the Bank of Canada hikes in July or not.
Brittany, thank you very much.