Canadian Dollar Outlook Deteriorates after Frosty Trump-Trudeau Encounter Stokes Fears of a "Zombie NAFTA"

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- CAD retreats after Trump hit out at Canada ahead of NAFTA deadline.

- ING analyst says NAFTA becoming a "zombie" as others sell the CAD.

- Goldman says deadline artificial, forecasts deal and CAD recovery.

The Canadian Dollar has been forced onto the back foot against its U.S. rival ahead of a key Sunday deadline for North American Free Trade Agreement (NAFTA) deal to be struck and analysts are warning of scope for further losses to come in the weeks ahead. 

President Donald Trump has set what some say is an artificial deadline of Sunday, 30 September for negotiators to reach an agreement on the terms of the future trade relationship between the U.S. and Canada.

However, the president's reportedly frosty response to Prime Minister Justin Trudeau's attempt to secure a one-on-one meeting at a United Nations summit Thursday has cast doubt over whether a deal can be done in time. 

"I’ve told him ‘forget about it,” Trump said to reporters Thursday, according to a report from The Globe and Mail. “We’re very unhappy with the negotiations and the negotiating style of Canada. We don’t like their representative very much.”

Some analysts are now concerned that NAFTA may be dying a slow death that will see the Canadian Dollar remain under pressure against its U.S. rival long into October. 

"The President’s negative tone over NAFTA and US-Canada trade talks has seen the CAD fall by around 0.60% overnight. The prospects of a ‘Zombie NAFTA’ may keep CAD under some pressure for now – while a formal break-up risks seeing USD/CAD at 1.35-1.36," says Viraj Patel, an FX strategist at ING Group, in a note to clients. 

With markets fixated on Sunday as the deadline for a deal, losses arising from that pressure could snowball ahead of the weekend in the absence of an intervention from the relevant negotiators or political leaders.

The deadline exists because U.S. officials want to have a bilateral agreement struck with Mexico ratified before incoming president Andres Manuel Lopez Obrador takes office at the beginning of December but U.S. law requires Congress to be given 60 days to review any trade bills before they are signed.

The plan has been to update the Mexico bilateral deal so that it includes anything that is eventually agreed with Canada while the sense of urgency is due to the fact that Mexico's Obrador might refuse to sign off on the new deal if that is left for him to do once in office. 

Obrador has criticised his predecessor for giving away too much in the talks and pledged to take a tougher stance toward Trump. Refusing to sign the deal would risk taking the negotiations back to square one, while marking an embarrassing set-back for the U.S. administration. 

The USD/CAD rate was quoted 0.12% higher at 1.3050 during noon trading Thursday and is up 3.7% for 2018, although the Pound-to-Canadian-Dollar rate was 0.21% lower at 1.7131 and is up just 1.1% this year. The Loonie was higher against most other G10 currencies for the session.

"If the US-Canada talks fail to conclude by the end of September, amendments can still be made to the draft text—even if originally only a bilateral agreement—up until signing at least 60 days later. Therefore, a trilateral agreement may still be signed by November 30 if the US and Canada are unable to reach a deal within the coming weeks," says Karen Reichgott, an economist at Goldman Sachs, in a note last week. 

The Goldman Sachs team are concentrated on November 30 as the real and final deadline. They have also told clients they are confident a deal will eventually be done and are forecasting a steep decline in the USD/CAD rate to 1.26 over the next three months. 

Trump's rejection of Trudeau came just days ahead of Friday's GDP data for the month of July, the detail of which will be key to whether or not the Bank of Canada (BoC) goes ahead with an interest rate rise next month. Another rate hike from the BoC in October is a critical assumption underpinning Goldman Sachs' bullish forecast for the Loonie. 

"A possible downside miss in growth should be taken in context with the headwinds that have surfaced for the loonie," says Mark McCormick, North American head of FX strategy at Toronto-headquartered TD Securities. 

McCormick and the TD Securities team say the trade deficit and current environment for foreign investment mean the trajectory of international capital flows is leaning against the Canadian Dollar.

Some fear U.S. tax cuts are drawing foreign investment away from Canada while the nation's own voracious appetite for investing overseas also tilts the balance of flows against the currency. 

This problem is made worse by a lack of clarity over the fate of NAFTA, which could be deterring investment away from the country, while NAFTA-induced uncertainty about the outlook for BoC interest rates is also playing its part. 

"We still like holding core short CAD exposure to the European majors like EUR and NOK. Following the break of the 200dma, we could see CADNOK grind lower and maintain long EURCAD exposure through riskies," McCormick writes, in a note to clients Thursday. 

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