NAFTA negotiations remain in the spotlight as we head into round six in January 2018. Brittany Baumann, Macro Strategist, TD Securities, talks to Sara D’Elia about what mattered in round five, what to watch next, and what’s in store for the loonie. Click here for the previous NAFTA update.
We continue to watch NAFTA negotiations, and today we're talking about what happened in round five and getting some insight into which topics investors should watch heading into 2018. Joining us again is Brittany Baumann from TD Securities. Thanks for being here.
Thanks for having me.
So we've just wrapped up round five about a week ago, and I have to ask you, what was your takeaway? Did we see any compromise in the last round of discussions?
So the conclusion of round five, in our view, was a step forward in the negotiation process. Now, for one, like in previous rounds, there was progress made on the less contentious chapters. But secondly, the more contentious proposals now, the ones that the US has presented that would be deal breakers to Canada and Mexico, because they're so draconian, there were signs of some emerging compromise that could be had on these specific issues.
Now, some examples of these proposals are the rules of origin and the sunset clause. And it appears that Canada and Mexico are now starting to offer counter proposals and something that the US could potentially concede on.
January 23, we're going to kick off round six. And you wrote in your report that each round of discussions now is becoming more and more important. Why is that?
So this has to do with the timeline of negotiations. So we started out the process in August with the goal of wrapping everything up by December. Now, that has since been extended into next year, so not exactly a bad thing. For one, there is the main goal of modernization of the agreement that has been in place for over 20 years.
However, this has also to do with the contentious proposals I've mentioned earlier that have made limited headway even though there has been some progress in the latest round. It's going to just take more time for negotiators to think things through.
And you also mentioned there is an implicit deadline coming up of March, which is pretty important.
So that is the new implicit deadline. So the goal is now wrapping everything up by March. Now, why by the end of the first quarter? Well, this is to end talks well ahead of a few key events happening later on in the year that could potentially complicate the process. And two examples of this is the Mexican general election in July and then the US midterm elections in November.
You brought a chart with you. We're going to get it up on the screen. You've highlighted three NAFTA risk scenarios and what each could mean for the Mexican peso and the Canadian dollar. On the left side, you'll see that your base case is that NAFTA will be renegotiated, and you have a 65% probability of that happening. You lowered your second scenario, that President Trump invoked Article 2205 to a 30% probability. And the final, at the bottom, is that they can't reach a deal and NAFTA is terminated, and you still have that at about a 5% chance. What are the key things you're watching going into 2018 right now?
So going forward, we will want to see at each successive round that there is progress being made. And one way to gauge that is if Canada and Mexico are offering counter proposals to what the US has already offered. Because until they do the US is unlikely to concede on anything. So then, the next round in January, that's something key to watch.
Now, our base case is for NAFTA to be renegotiated and signed by all three parties without the use of the so-called Article 2205, which is effectively a six-month notice to the other two parties of termination. However, I would mention that it is non-binding. So in that case, we do give that still a non-trivial risk just based on Trump's own negotiating tactics he may have in mind. So specifically, if talks drag further into the year, he might feel pressured to take action and really act on his own campaign promises of renegotiating the agreement.
But in that case, however, that would not necessarily mean that the agreement would be terminated. We think it's in the US's best interests to create a new trade agreement to put in place, keep in place free trade in all three countries. And this is really due to the industry pushback. We've seen industries across the board do want to keep NAFTA in place. And then we also have to keep in mind that we have a Republican Congress that's still very much pro free trade.
And let me just ask you to close things off-- the impact for markets, what do you think that could be?
So in the case where Article 2205 is invoked by Trump, which is a non-negligible risk, that would have significant impacts on the Canadian dollar-- mainly because nothing is really priced in at this point. There is no NAFTA risk premium as what we've seen in the Mexican peso for instance. So in that case, we do see the Canadian dollar going to roughly $0.20, and this is really because rate hike expectations would probably be priced out. And right now, they are pricing in a normalization path by the Bank of Canada.
That being said, I think that's where the significant impacts end. And in terms of the economic impacts, probably very modest mainly because NAFTA does remain in place for at least six months. And then if the agreement is eventually terminated, it takes up to a year for the agreement to actually end. So trade flows would continue. Should we have tariffs down the road, they do average relatively low levels, around 3% to 4% in both the US and Canada. So this would raise firms' costs, but it would not be a significant shock to the economy.
Thank you very much.
Thanks for having me.