Canadian Dollar Rises on Fresh NAFTA Optimism, Goldman Sachs Forecasts Continued Gains

Image © Bank of Canada

- CAD rises as NAFTA optimism renews ahead of deadline for deal.

- Goldman Sachs say CAD to go on rising, as a deal will be reached.

- September deadline is artificial, October agreement possible if not likely.

The Canadian Dollar advanced against rivals Wednesday amid renewed hopes a deal to save the North American Free Trade Agreement (NAFTA) could be announced before the week is out, and analysts at Goldman Sachs are forecasting the Loonie will continue to rise over coming months.

Officials from both sides of the U.S.-Canada border are thought to be aiming for an agreement before the end of September. After that point U.S. legislators will not have the necessary 60 days to scrutinise the deal ahead of its signing, which is required by law, before incoming Mexican president Abdres Manuel Obrador Lopez takes office in December.

"USD/CAD broke below 1.3000 on news that Foreign Minister Freeland will meet with USTR Lighthizer in Washington today. US officials warned that time is running out for Canada and the US to reach agreement. Support is located at 1.2956, with resistance at 1.3020," says Adam Cole, chief currency strategist at Toronto-headquartered RBC Capital Markets.

Mexico's Lopez accused his predecessor, Enrique Pena Nieto, of "selling out" the country in the NAFTA talks and pledged to adopt a tougher line in dealing with U.S. president Donald Trump, who once described the pact as "the worst deal in history" and pledged to renegotiate or terminate it.

Nieto's government agreed a new U.S.-Mexico trade deal back in August, which left Canada with only limited time to either accept the terms of that agreement or negotiate an alternative. But Obrador has since called for Canada to be included in the new agreement so any pact remains a trilateral one.

It's possible the White House and U.S. legislators want a deal before December because they are concerned that Obrador may then seek to reopen trilateral discussions. Either way, the Goldman Sachs team suggest the September deadline is an artificial one and are forecasting continued gains for the Loonie even if a deal is not reached this month.

"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 Wednesday.

Stymieing progress in the talks is a U.S. demand to abandon the Chapter 19 dispute resolution mechanism in the existing NAFTA agreement, which empowers an arbitration panel to settle disputes with binding rulings.

Washington has also demanded, among other things, that Canada lift tariffs on imports of U.S. dairy goods and do away with subsidies of the politically-powerful dairy industry.

"Members are concerned that Canada does not seem to be ready or willing to make the concessions that are necessary for a fair and high-standard agreement. While we would all like to see Canada remain part of this three-country coalition, there is not an unlimited amount of time for it to be part of this new agreement," says Steve Scalise, majority whip in the U.S. House of Representatives, in a statement Tuesday. 

Canadian Prime Minister Justin Trudeau said at the end of August "we're not going to do that" and, although he has since hinted at a willingness to make concessions on the dairy sector, it remains to be seen whether there will be concessions around Chapter 19.

Chapter 19 enables companies and NAFTA signatories to challenge decisions by other signatories to impose things like anti-dumping duties on goods imported from other signatories. President Trump imposed tariffs on imports of Canadian steel and aluminium back in May in the name of "national security". 

"We still think the most likely scenario is a trilateral NAFTA agreement. Many members of Congress in both parties have suggested they might oppose an agreement that excludes Canada. If Congress will not approve a bilateral NAFTA revision, this would leave the White House with only two options: negotiate a trilateral deal with Canada and Mexico, or withdraw from NAFTA entirely. The White House has faced this same choice for more than a year now, and it has chosen to continue to negotiate a trilateral agreement, so we expect that it will continue down this path," says Goldman's Reichgott. 

Reichgott and the Goldman team say that although a deal may still come inside September, it is equally possible that an agreement won't be reached until some time in October. This is in part because there is an election on October 01 in Quebec, which alonside Ontario has among the largest share of dairy farms in the country. Voters in those promises might respond to concessions on the dairy sector by voting for the opposition. 

"A 25bp narrowing in the US-Canada 2-year rate differential, all else equal, implies up to a 3% decline in USD/CAD. In other words, we could see a 4-big-figure move to 1.26 from current spot levels on headlines of a US-Canada trade deal," Reichgott writes. "This simple exercise supports our bearish USD/CAD forecast over the next 3 months of 1.25 as the US-Canada 2-year rate differential appears too wide, in our view, when considering the similar performance and stage in the business cycle of the two economies." 

Goldman's forecast for the USD/CAD rate is based on the expectation that the Bank of Canada (BoC) would go ahead and raise its interest rate later in October, after a deal is reached. The BoC frequently cites trade "uncertainty" as one of the more significant stains on an otherwise rosy economic picture.

Most analysts expect the BoC would continue raising rates if a NAFTA deal is reached but that it could stop hiking, or maybe even cut rates, if President Donald Trump terminates the NAFTA deal. Toronto-headquartered TD Securities has previously said a US withdrawal would lead to a 20% fall in the value of the Loonie as markets would be forced to mark down their assumptions about longer term growth and interest rates.

The USD/CAD rate was quoted 0.07% lower at 1.2963 during noon trading Wednesday but is up 3% for 2018, while the Pound-to-Canadian-Dollar rate was 0.19% lower at 1.7048 and is up 0.67% this year. The Loonie was also higher against most of the rest of the G10 basket. 

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