Canadian Dollar Slips after Trade Deficit Widens; NAFTA Negotiators Meet in Washington

-Canadian Dollar slips after trade deficit widens in February.

-Trade data overshadows fresh hopes of a deal on NAFTA.

-Negotiators attend informal meeting in Washington Thursday.

© Stockyme, Adobe Stock

The Canadian Dollar pared earlier gains during noon trading in London Thursday after the Canadian trade deficit was shown widening much further than was expected during the February month, overshadowing a bout of renewed optimism over the future of the North American Free Trade Agreement.

Canada’s trade deficit rose to -$2.7 billion during February, which is up from -$1.9 billion in January and a much larger deficit than the -£2.1 billion that economists and markets were looking for.

The widening mismatch came after imports into Canada rose by 1.9% during February while exports grew by only 0.4%. Increased purchases of industrial machinery were behind the import surge while shipments of car parts were behind the more meagre growth in exports.

Trade balance data measures the difference in value between a nation's imports and its exports. Currency markets care about it as the data provides insight into supply and demand for a currency in the "real economy".

“Overall, while export volumes did rebound, removing some of the negativity surrounding this report, they remain disappointing given the strong US economy and weak Canadian dollar. The data should be positive for fixed income, as it plays into our forecast for a patient Bank of Canada, and bearish for the Canadian dollar,” says Royce Mendes, an economist at CIBC Capital Markets.

Above: USD/CAD rate shown at daily intervals.

USD/CAD was quoted 0.25% higher at 1.2786 a short time after the release while the Pound-to-Canadian-Dollar rate was 0.18% lower at 1.7932. The Canadian Dollar saw a mixed performance against all other G10 currencies.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

NAFTA: Hope on the Horizon?

Thursday's data comes hard on the heels of statements from Canada's Foreign Affairs Minister Chrystia Freeland, who told a Winnipeg Chambers of Commerce audience Wednesday night that negotiators are hopeful an "agreement in principle" can be reached this April on the future of the North American Free Trade Agreement. Freeland is in Washington meeting with US Trade Representative Robert Lighthizer and Mexican Secretary of the Economy Ildefonso Guajardo Thursday.

Bloomberg News reported earlier this week that President Donald Trump is reported to be pushing for an early agreement on the renegotiation of NAFTA so that it can be announced at the Summit of the Americas, which begins on April 13. However, given there are no official plans for another round of negotiations this month it appears any deal will have to be thrashed out through a series of informal meeting such as the one scheduled for Thursday.

Negotiators are working against the clock too. Not just because of a reported desire in the White House to see a deal announced at April's summit, but also because campaigning activities for July's Mexican Presidential election and the Autumn's midterms in the US are expected to see talks placed on hold until the end of the year if a deal cannot be struck.

Renewed hopes of an agreement come barely a week after the Globe and Mail reported the White House has dropped a key but contentious demand on an increased "US content requirement" for cars that are shipped across the borders from Canada and Mexico into the United States. However, there is a range of other key issues that are yet to be resolved.

A NAFTA breakup has been and remains the most potent risk to the Canadian Dollar given the anticipated economic damage it would cause, which some analysts estimate could lead to a double digit devaluation of the Loonie. 

President Trump once described the pact as "the worst deal in history"while on the campaign trail and threatened to tear it up if more palatable termscouldn't be agreed. US, Mexican and Canadian representatives have been attempting to thrash out a new agreement ever since early 2017.

Bank of Canada on Hold?

Saving NAFTA matters to the Canadian Dollar not just because of the anticipated economic fallout in the even it is torn up, but also because the trade and business uncertainty created by ongoing negotiations is having an impact on the Bank of Canada's assessment of the economy and market expectations for interest rates over the coming quarters. 

The Bank of Canada raised interest rates three times between July 2017 and January 2018 while, at the time of the last hike, markets were betting heavily that policymakers would pull off a total of three interest rate rises before year-end. 

Since then things have changed and now pricing in interest rate derivatives markets suggests investors expect only one more move this year, and that they are unsure of when it will come. Strategists have given up calling for a rate hike in April and their forecasts are now increasingly converging on the July meeting. 

NAFTA risks have no doubt contributed to the deterioration of expectations for Canadian interest rates although a slower pace of economic growth has also played a substantial role. Data showed in March that the Canadian economy contracted in January, for the second time since the BoC began raising rates last July, which has had an impact on economist expectations for growth in the first quarter overall.

Markets are increasingly looking for growth of between 1% and 1.5% on an annualised basis for the three months to the end of March, although the Bank of Canada has been looking for GDP growth of 2.5%, which suggests the monetary policy meeting on April 10 may see fresh downgrades to the BoC's growth forecasts and some dovish commentary on the outlook for monetary policy. 

However, all of that said, currency strategists are increasingly forecasting substantial upside for the Canadian Dollar if negotiators reach a deal to preserve the NAFTA pact. The Loonie has fallen by 2% against the US Dollar in 2018, by more than 6% against the Pound and nearly 5% relative to the Euro. It could convert these losses into a 7% gain if negotiators are succesful in coming weeks.

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