Canadian Dollar: Election Result Means Mexico's NAFTA is Stance Set to Harden

-Landslide for Obrador in Mexican election is a curveball for CAD.

-Obrador is seen as "being able to stand up to Trump" in NAFTA talks.

-Metals retaliation sees risks around Canada-US trade relations rising.

© Goodpics, Adobe Stock

The Canadian Dollar continued to rise against its developed world rivals Monday but fell relative to the US Dollar and Yen, both so called safe-haven currencies, in a telling sign of what may be to come for the Loonie now the 2018 Mexican election has vaulted an outsider candidate into the highest office of the country.

Andrés Manuel López Obrador, an anti-establishment leftist, won the Mexican presidency with a landslide result in Sunday's election that may now have afforded him a Congressional majority large enough to facilitate constitutional reform. With just more than half of the vote counted Mexico's National Electoral Institute said Monday that Obrador had 53.7% of the vote, leaving his nearest competitor trailing with just 22% support.

Obrador campaigned heavily on an anti-corruption ticket and was a firm favourite in opinion polls to win the presidency, but has said very little about how he would handle the North American Free Trade Agreement (NAFTA) negotiations beyond stating that he will put President Trump "in his place". He has also called repeatedly for talks to be suspended until after the election because the "weak" incumbent president is in danger of "selling out" the country.

"We take it as given that Mexico and the U.S. both want a deal to succeed, given the great economic importance to the two countries of the trade agreement. The desire of the U.S. to negotiate bilaterally, if need be, supports this notion. However, with the election now upon us and AMLO's preference to have his representatives involved in future negotiations before he takes office, it's unlikely that negotiations get any easier in the coming months. This increases the probability of negative headlines and hard-line rhetoric," says Sacha Tihanyi, deputy head of emerging market FX strategy at TD Securities.

Tihanyi says the prospect of a further deterioration in relations between the US and Mexico, as well as uncertainty about the new government's fiscal agenda, will mean international investors are likely to continue giving the Mexican Peso and Mexican government bonds the cold shoulder during the weeks ahead. Presumably, the risk premium being built into the Canadian Dollar, via lower exchange rates, is unlikely to reverse under this kind of environment either.

The USD/CAD rate was quoted 0.44% higher at 1.3194 during the morning session Monday while the Pound-to-Canadian-Dollar rate was 0.06% lower at 1.7309. The Canadian Dollar was higher against all developed world currencies other than safe-havens such as the Japanese Yen and US Dollar.

The incoming President will not take office until the end of December 2018 but has been pushing for immediate involvement in the NAFTA talks. While little is known of his plans for the US-Mexico trade relationship Obrador's rhetoric means it is generally thought that the Mexican stance in the negotiations may now harden, although he was swiftly congratulated by President Donald Trump on Monday.

Congratulations to Andres Manuel Lopez Obrador on becoming the next President of Mexico. I look very much forward to working with him. There is much to be done that will benefit both the United States and Mexico!

— Donald J. Trump (@realDonaldTrump) July 2, 2018

"López Obrador has already threatened that he would cancel an agreement that was disadvantageous to Mexico," says Alexandra Bechte, an analyst at Commerzbank. "Obrador is seen as being able to stand up to Donald Trump. Both are said to pursue a similar style of politics. That will not make negotiations any easier – whether they will succeed or fail is not up to Mexico alone, though."

Officials from Canada, the US and Mexico have been attempting, without success, to renegotiate the North American Free Trade Agreement for nearly a year now. Fears are that the US will simply withdraw from NAFTA if it cannot secure new terms that are more agreeable to the White House, which TD Securities has previously said could lead to slower economic growth, lower interest rates for a longer period and a double-digit fall in the Canadian Dollar.

Canada Strikes Back, Where Next?

President Trump has been pursuing restrictive legislation to govern Chinese investments into the United States and recently ordered that a range of tariffs be levied against imports of more than $250 billion in American imports of Chinese goods. He has also been attempting to reduce the US trade deficit, citing it as a sign of malpractice by other countries in the international trade arena and evidence that protectionist action is needed by the White House.

The moves so far have drawn retaliation and threats of even further reciprocal measures from the Chinese, which all comes on top of earlier White House tariffs on imports of steel and aluminium into the United States from across the globe, including the European Union. The EU has since responded with its own levies on US motorcycles, jeans and whiskey, drawing threats of even more tariffs from the White House, this time targeting the mighty European automotive sector.

"PM Trudeau celebrated Canada Day by implementing retaliatory tariffs on nearly $13b worth of goods which may set up an even more significant escalation by US and potentially on autos. The latter could be detrimental to Canadian growth prospects moving forward. This is hardly a backdrop that favors CAD gains in recent sessions to be sustained," says Mazen Issa, a senior FX strategist at TD Securities.

"Indeed, now with the market 75% priced for a hike this month, the good news is in the price and setting up for a classic buy-the-rumor-sell-the-fact scenario into the July meeting. This leaves us looking at CAD’s return profile as asymmetric to the downside still, particularly at a time when US and Canada have entered a trade spat."

A solid recovery in Canadian economic growth during April was last week seen setting up the Bank of Canada to push ahead with a July 11 interest rate rise, which helped lift the Canadian Dollar Friday and should, in theory, support the currency going forward.

However, Monday's Canadian retaliation against US tariffs on its exports of steel and aluminium, with equal levies on around $12 billion of Canadian metal imports, now open the door to a possible counter-attack from the US and a further deterioration in relations. It was only a few hours before the US responded to an earlier retaliation from China back in May.

Early in June President Trump hit out at Canadian Prime Minister Justin Trudeau on Twitter, attacking Canada's high tariff rates on US dairy products and accusing the nation's ministers of having taken advantage of the US for "too long".

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