As trade negotiators prepare to meet in Mexico this week, Wall Street is increasingly worried the 23-year-old NAFTA trade deal could fall apart, creating the potential for new trade clashes in North America and around the globe.
Analysts say tough "America first" trade
The talks enter a fifth round Wednesday, and the U.S. has been attempting to narrow a $60 billion trade deficit with Mexico and modernize the agreement on such things as intellectual property, digital trade and financial services. After the last round, U.S. Trade Representative Robert Lighthizer said he was "surprised and disappointed by the resistance to change" by Mexico and Canada on these fronts but added there has been some movement on modernization.
"There are lots of scenarios where this thing just dies. You can't rule that out," said Greg Valliere, chief global strategist at Horizon Investments. "I think that [Trump] just sent a signal in that speech that he doesn't want any kind of multilateral deals. He just wants bilateral deals. To be fair, you could say we could cut a deal with [Canadian Prime Minister Justin] Trudeau, maybe with Mexico. And with [U.K. Prime Minister] Theresa May. There are options."
But there is also downside and the potential for increased U.S. protectionism. "There are already trade disputes between the U.S. and Canada on lumber and dairy products. We slapped tariffs on their aircraft. There are already issues. There could be a fight with China over aluminum and steel. I just worry these things become more numerous," Valliere said. Trump is expected to make a trade announcement Wednesday, but analysts do not expect it to be about NAFTA.
Sticking points in the negotiations have been over new rules of origin, with the U.S. seeking that 85 percent of any automobile to be sourced to NAFTA countries, with 50 percent of the total coming from the U.S., whereas current sourcing rules are for 62.5 percent to be made in NAFTA countries. The U.S. imports billions of dollars in car parts from Mexico annually, in addition to actual automobiles. Other points of disagreement have been the U.S. insistence on dropping a process to resolve disputes and also the addition of a five-year termination clause.
"They're making great progress in the Congress on the tax bill. Is this really where you want to go and offset some of those benefits? But polling is strong on this on NAFTA, and this may be something they want to do," said Daniel Clifton, head of policy research at Strategas Research. "I think the market will extrapolate a larger global trade war if that happens."
Jens Nordvig, Exante Data CEO, sent out a warning note Monday that his firm now sees a 30 to 40 percent chance of NAFTA "blowing up" by March.
While Ian Bremmer, president of Eurasia Group said in a note Monday that he has long thought there was 50/50 chance NAFTA would fall apart, but he is also becoming increasingly concerned.
"The big risk is that trade tension in NAFTA spreads to a more global stage, for example if the EU sides with Mexico in WTO disputes. This is where the global risk grows very large," Nordvig said in an email.
The potential economic impact is unclear but there would be an immediate response in the currency markets. Nordvig points out that the peso fell to a low of 22 vs. the dollar in January. It was at about 19.15 Monday.
"If NAFTA blows up, it is very vulnerable," Nordvig notes, adding Mexico could turn politically to the left in its upcoming presidential election. "Hence, we are talking about potentially very significant [peso] weakness in a NAFTA blow-up scenario, especially if it drives political changes in Mexico also."
He said the Canadian dollar would also against the U.S. dollar if NAFTA ended. "But that is not the case globally. In fact, I think over the medium-term, [euro] and [Chinese yuan] would benefit from the U.S. "America First" policy, as it has to make the [dollar] a less attractive reserve currency," Nordvig noted.
The economic consequences of the end of NAFTA are unclear but Valliere notes that American farmers could be among the groups that feel impact since they are big exporters. The U.S. had a $12.5 billion surplus with Canada in 2016, and it traded $628 billion in goods and services with the U.S. last year, compared with Mexico's $580 billion.
Bremmer said Canada and Mexico also see the potential for the talks to fall apart. "Both now have plans well underway for how to respond to what a NAFTA-less North America looks like. The economic hit is equally clear for both, but the politics are another matter," he wrote. "Anti-Trump sentiment in Canada is so high that there's not likely to be much fallout for Trudeau and his liberal party if the relationship falls apart. Meanwhile, Mexican president Enrique Pena Nieto is ostensibly the pro-Trump guy; this has a huge impact on next year's elections."
The bigger impact would clearly be on Mexico's economy and businesses. There has been a significant decline in stocks of Mexican companies that have large exposure to the U.S., according to Strategas.
Source: Strategas Research
"The Mexican authorities are trying to downplay the affects so they're putting out numbers about how much trade already goes under WTO rules and non NAFTA rules. They're trying to talk about diversification of markets. They talk about the growth of imports from Argentina and Brazil," said Juan Carlos Hartasanchez, senior director at Albright Stonebridge Group. He said imports, largely grain, have grown 10 to 15 percent in the last year from Brazil and Argentina. "They logically have to boost confidence. However, the impact is still strong. I think GDP would suffer…It definitely would be an important hit to GDP just because of the sheer size of Mexican U.S. trade."
Hartasanchez said if the U.S. does withdraw from NAFTA, Mexico has said it would not remain at the table though the actual withdraw would be six months away. "The way [the U.S.] could justify getting out is saying the blame falls on Mexico and Canada and saying they weren't willing to renegotiate," he said.
In an editorial, the Wall Street Journal Sunday said the biggest threat to Trump's economy is his trade agenda. The newspaper pointed to its own poll that said 82 percent of economists surveyed said the economy would grow more slowly for the next two years that it would have otherwise, but only 7 percent expected recession. "That underestimates the risks of recession in our view, given the political shock from such a reckless act by a U.S. President and the damage that would ensue to North American and even global supply chains," the editorial said.
Valliere said free trade has become a target of both the left and far right. "People don't like free trade anymore. It's unpopular," he said. "I think you could make a compelling case that it's helped the U.S. It's helped our export sector. It's brought in goods that are low priced and that's been good for consumers… But there is a focus on the people who have been hurt."