For Canadian Dollar a 'No Deal' on NAFTA Negotiations is the Key Threat Going Forward

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- CAD benefits from Mexico-US trade agreement

- But gains limited as traders eye tougher Canada-US talks

- "If Canada is left out – that’s CAD bearish. Full stop" - CIBC

The Canadian Dollar is in focus as news of a Mexico-US breakthrough in NAFTA talks prompts traders to bid the currency in anticipation of a potential Canada-US breakthrough.

While the Canadian Dollar is certainly heading higher, the gains are not extraordinary, confirming traders are tempering their enthusiasm on the observation that breaking the Canada-US deadlock will be harder to achieve.

Indeed, the prospect of a 'no deal' between Canada and the US is eyed as a key risk to the Loonie over coming days.

The deal between the US and Mexico effectively puts paid to the 25-year old NAFTA tripartite deal between the US, Mexico and Canada and confirms US President Donald Trump is making progress in his agenda to eradicate bloc trade deals.  

With Mexico and the US finding agreement there are growing hopes that Canada and the US will strike a deal soon.

"In the short-term, a deal is a much better than no deal. That’s the main reason why the risk premium attached to the MXN and CAD has been reduced today," says Bipan Rai, an analyst with CIBC, in the wake of news of the Mexico-US success.

Trump and Canadian Prime Minister Justin Trudeau discussed trade in a telephone call in the wake of the Mexico deal and both sides “agreed to continue productive conversations,” White House spokeswoman Sarah Sanders said in a statement.

Canadian Foreign Minister Chrystia Freeland is meanwhile expected to travel to Washington for talks on Tuesday. Her spokesman said Canada would sign only a new agreement that is good for the country.

The moves by the Canadian Dollar while positive, were not necessarily extraordinary. For instance, the Pound-Canadian Dollar exchange rate traded a low at 1.6691 in the wake of the developments, having opened the week at 1.6728. The US-Canadian Dollar exchange rate traded a low at 1.2949 having opened the week at 1.3020.

The best GBP into CAD international payment rates on the market are now seen lying in the 1.6622 region by our estimates, but the rate could well improve if Canada does not give ground to the US in negotiations.

Indeed, while the mood surrounding CAD has certainly improved in the near-term, there are warnings that the ability of the US and Canada to strike a deal might be less easy to come by.

"There is still significant risk that Canada gets left out in the cold. That risk increases substantially if the Trudeau government digs in and decide that the new agreement does not suit them. There will have to be some give on the Canadian side when it comes to ‘line-in-sand’ issues such as Chapter 19 or the ‘Buy American’ provision," says Rai.

Strategists at TD Securities meanwhile believe positive momentum stemming from the progress in talks is liable to be short-lived.

"The US and Mexico reached a bilateral deal, effectively terminating NAFTA, while leaving the door open for Canada to rejoin (with less leverage). An in-principal agreement is worth a knee-jerk in the headlines, though it is unlikely to offer much momentum beyond that," says a note from TD Securities' European desk on Tuesday, August 28.

TD Securities do believe the agreement between Mexico and the US will put pressure on Canada to reach an agreement and Michael Hanson, Head of Global Macro Strategy with TD Securities, says the Canadians are likely to agree to the terms laid out by the US.

"We do not yet know how the new agreement will address some of Canada's concerns, nor do we know how the Canadian government will respond. Still, Canada lacks leverage in the negotiations, and with President Trump threatening auto tariffs in the absence of a deal we expect that Canada will eventually agree to terms," says Hanson.

Announcing the preliminary US-Mexico deal, Trump declared that "one way or another
we'll have a deal with Canada," but he threatened that "it'll either be a tariff on cars on it'll be a negotiated deal."

Mexico finally agreed to US terms that 75% (62.50% in NAFTA terms) of auto content should be built on US soil, while being exempt from tariffs along with a minimum wage of $16/hour insured for 40%-45% of total US auto parts workforce.

Canada is expected to counter-offer on this, paving the way for further talks. It is believed this negotiating approach adopted by Trump is designed to put the ball into Canada's court to either agree to a deal or face further US protectionist actions.

"American-Mexican bilateral talks initiated last month are coming to an end, putting pressure on Canada to sign or resign from the 24-year-old treaty. Canada must return to the negotiation table, and this will not be a loonie-positive," says Vincent-Freìdeìric Mivelaz with Swissquote Bank in Gland, Switzerland.

Mivelaz says a strong bounce above 1.32 in USD/CAD cannot be ruled out in coming days.

"Currently trading at 1.2955, USD/CAD is expected to strengthen slightly, as hope grows that Canada will accept current terms – we think this is unlikely," adds the analyst.

Bad for the CAD

Trump appears unwilling to offer Canada any major concessions and in doing so leaves Canada's Trudeau in a difficult position, particularly now that the Mexican-US deal leaves him with a weakened hand.

If Trudeau digs in Trump could well act unilaterally, and this could have notable implications for the Canadian Dollar we are told.

"If Canada is left out – that’s CAD bearish. Full stop," says CIBC's Rai. "No deal implies that we’re looking at a scenario where auto tariffs from the US come into play and domestic investment is likely to slow."

At the very least, that pushes out Bank of Canada rate hikes to a degree argues the CIBC analyst.

This however isn’t CIBC's base case scenario as they do envision that Canada will come to terms with the US/Mexico.

"For markets: The deal or no deal play is what matters for Canada and the CAD this week. Markets are already pricing a deal so the risk has become asymmetric towards a no-deal scenario. If you’re concerned about the CAD - keep that in mind and worry about the details later," adds Rai.

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