Wins, losses and market effects of the new trade deal

The loonie rallied Monday as the market responded to news of Canada joining a revamped North American trade deal.

The loonie reached $1.28 (78.1 U.S. cents) on Monday for the first time in about five months, reflecting the greater certainty of the Bank of Canada raising interest rates in the coming months, says a CIBC report.

The market is basically “scrubbing out risk of a negative outcome” that had been built in, says a BMO report outlining the new United States-Mexico-Canada Agreement (USMCA).

The deal agreed to late Sunday avoids punitive auto tariffs and preserves the Chapter 19 dispute resolution mechanism, while opening up Canada’s dairy sector to U.S. products.

CIBC expects the central bank to hike rates this month, with the next hike coming in January. BMO is now calling for three hikes in 2019—January, April and July.

Still, CIBC tempers growth expectations. While the Bank of Canada imposed a 0.2 percentage-point-per-year drag on growth from trade uncertainties, the report says, “it won’t lift all of that in its next forecast, given that the steel/aluminum issue remains unresolved.”

For its part, BMO says the deal “heavily reduces lingering uncertainty” for the 2019 economic outlook, but the central bank will still want to see evidence of business investment and capacity before revising its GDP forecast. Since BMO assumed a deal would be reached in its base case, GDP growth forecasts now have upside potential, it says.

BMO notes that the loonie still faces challenges longer term. Broader policy changes are needed to address Canada’s competitiveness, it says, so any further loonie strength will be limited.

“Prior to the deal, we were looking for 78.5 cents ($1.275) for the end of this year and 80 cents (or $1.25) for the end of 2019,” says the BMO report. “We remain generally comfortable with that call.”

CIBC says Canadian equities affected by the trade woes should garner some support. BMO says that support “will be more of a case-by-case basis” in areas such as auto parts, some industrial products and dairy.

Auto suppliers Martinrea International Inc. (up 11%), Linamar Corp. (up 7.6%) and Magna International Inc. (up 4.8%) saw big gains in early trading, Bloomberg reported.

BMO adds that, if the deal improves sentiment toward Canadian equities more broadly, then the gap in forward earnings yields relative to U.S. equities could narrow.

The trade deal isn’t a cure-all for Canada’s export sector, though, says CIBC. “Real exports from the U.S. are up 75% from 2000 levels, but Canadian real exports have seen little growth over the same period,” it says.

To turn that around, the loonie must be kept range-bound or weaker over the medium turn, it says.

“That should still see the Bank of Canada trail the Fed, hiking only 50 [basis points] in total in the next few quarters,” says CIBC. In contrast to BMO, CIBC says, “Look for the Canadian dollar to return to the low 1.30 range in 2019 as the BoC is outgunned by the Fed.”

Good news for Canada

While the new deal isn’t “a game changer,” CIBC says, it avoids punitive auto tariffs and preserves the Chapter 19 dispute resolution mechanism. Chapter 19 has been historically instrumental in maintaining fair trade practices, especially in lumber. The mechanism “limits the ability of the U.S. or Mexico to impose arbitrary anti-dumping and anti-subsidy duties at their discretion,” says the report.

Chapter 20, the government dispute resolution mechanism, also remains in place.

More good news: NAFTA’s Chapter 11 won’t apply to Canada anymore. Under that mechanism, companies from one country could sue for damages arising from policy changes affecting its investment in the other. With Mexico, Chapter 11 will be retained in some sectors—oil and gas, infrastructure and telecoms. These developments represent “the best possible outcome from the Canadian standpoint,” says CIBC.

CIBC’s report highlights other wins: the U.S. dropped its demand to sharply reduce access to U.S. government procurement contracts, and agreed to at least a 16-year term for the deal (with a review at the six-year mark).

And, while the U.S. could move forward with auto tariffs on global auto imports, Canada won’t be affected.

“Canada has negotiated a quota for tariff-free exports of autos stateside amounting to a level that is roughly 40% higher than current exports,” says the CIBC report. “That should provide a buffer for as far as the eye can see, as long as the product meets North American content requirements, which have been inflated from 62.5% to 75%.”

BMO says the agreement on autos is a “net positive for Canada.”

Where Canada loses

On the minus side, U.S. dairy exporters will have better access to Canadian consumers, as Canada conceded about 3.5% of its protected dairy market.

While the dairy concessions aren’t popular with Canadian producers, they’re potentially a benefit to consumers, says CIBC.

With dairy import quotas to be phased in over six years, the BMO report says, “Ottawa believes that the industry can gradually adjust to the changes.” Further, dairy farmers will receive compensation, to be worked out in coming months, Foreign Affairs Minister Chrystia Freeland told reporters in Ottawa Monday.

Potentially affecting Canadians’ drug costs, drug makers received an extended patent protection period of 10 years from eight years previously. The BMO report describes this portion of the deal as the one “clear negative for Canada.”

Also, Canadian retailers could face more competition from online sales, because the ceiling on goods that can be shipped across the border while avoiding tariffs increased to $150 from $20.

Tariffs still in effect

U.S.-imposed tariffs on steel (25%) and aluminum (10%) stand, as do Canada’s retaliatory tariffs. However, progress may be made on that front, says CIBC, with talks expected. Further, the U.S. agreed to give Canada and Mexico advance notice and a window of negotiation should it find new industries that it wants to subject to these so-called national security tariffs.

“Uranium has been mentioned in that regard,” says CIBC.

Read the full reports from CIBC and BMO.