Round four of NAFTA negotiations have wrapped up leaving many Canadians worried that a deal may not happen. Brittany Baumann, Macro Strategist, TD Securities, talks to Sara D’Elia about whether Canadians should brace for a trade war and what renegotiations could mean for the economy.
Thanks for having me.
So before we went into these negotiations, Brittany, the one thing you told me you were worried about was the possibility that they wouldn't reach a deal, and we would go into 2018. Fasforward. That happened. Now, what?
So, yes, we learned this week that talks will be formally extended into next year, so that was largely what we were expecting, basically because the agreement hasn't been reviewed in over two decades. So a lot needs to be modernized, extended to certain areas, such as e-commerce, for instance. However, there is a lot of other areas or points of contention on the table that likely will take a very long phase of negotiations in order to get all three countries on board. So at this point, talks are expected to extend into Q1.
There were a lot of worries about the potential that the US could walk away from the deal, but you've actually done an analysis and pinned that at a probability of less than 5%. How come?
So that is a concern mainly because President Trump himself has threatened to pull out of the deal. He did that once again last week. We think the risk of that is still low at this stage, mainly because, first, we think this is largely a negotiation tactic from the US administration.
Secondly, we find that there's very limited political or economic motive to actually pull out. The US would be worse off without NAFTA. And secondly, there's a very substantial industry pushback as well, so he is feeling the heat from many industry groups, from lobbyists. So also, not very-- doesn't really make much political sense in his mind, I would think.
Let's say this worst case scenario happens. The US walks away. What does termination of the deal look like?
So President Trump does have the right to pull out of NAFTA by invoking Article 2205, so that would effectively be a six-month notice to both Canada and Mexico. Important to note that it is not binding, so at the end of six months, the US doesn't have to pull out. So basically, if this occurs, negotiations would continue. NAFTA would remain in place. Should the US still feel that it would like to pull out at the end of six months, that's when the official termination would take place.
Now, what would happen in that circumstance? US and Canada trade would actually revert back to the previous trade agreement that was superseded by NAFTA, so in that case, goods would remain tariff-free. The bigger concern is, what about all the other changes that took place in NAFTA, specifically for services, for certain labor protections, for dispute settlement? So I would say, at this stage, it would be probably a small net negative for Canada, a lot because of that uncertainty. But it would still be a much better outcome than going back to actual tariffs being put in place, so under WTO rules.
If we do walk down this path of a worst case scenario and the US were to leave the agreement, it sounds like there's a bit of a safety net. There are some unknowns. But despite all of these considerations, Canadian businesses are pretty optimistic right now. Why is that?
So this is very important. We look at business surveys because they provide the most timely indicators of economic activity. So in times of great uncertainty, as in the current environment, these surveys could, in a more timely way, capture any deterioration in business sentiment resulting from, let's say, uncertainty over NAFTA, in this case. What we're seeing, actually, is in surveys up until now is that businesses remain optimistic about the future, and it's pretty much business as usual in terms of production, new orders, employment intentions.
So what we would be concerned about is if there is any kind of delayed investment intentions going forward. And in terms of how this would impact the outlook for the Bank of Canada, in particular, they are especially focused on surveys such as the Business Outlook Survey. Now, for the Fall Survey, we saw that, on balance, it was positive across the board. So that kind of takes the pressure off of being overly concerned over the negative implications of policy, uncertainty, and in our view, largely underpins our view that the bank will be able to continue hiking in response to the strong data we're already seeing, particularly in the labor market and on the growth side of the economy.
Quickly, let me ask you, in terms of potential hikes from the Bank of Canada, how many do you think we could see? And what do you think this means for the loonie?
So our view is that we expect the bank to hike twice over the next year, so by year end 2018, and for those hikes to come sooner rather than later. So our official view is that they can hike again in December, and that would be followed by a hike the next quarter, most likely in March.
Now, in terms of what this means for the Canadian dollar, because we're going to get more rate hikes by the Bank of Canada, we do expect the loonie to appreciate from here and eventually top out at, roughly, $0.84 on the dollar. Now, because we expect the Fed to continue hiking, and we expect three more hikes by the end of next year, we do expect the loonie to roughly remain the same at current levels by the end of next year, so going back to roughly $0.79, $0.80 on the dollar.
Thank you very much. Look forward to having you back to chat about NAFTA.