Insights and Market Perspectives

Why the USMCA may lead to higher interest rates

October 4, 2018

Canadian investors may have one less headwind to worry about now that Canada, the U.S. and Mexico have shaken hands on a refurbished free trade agreement, but in the wake of the deal, the risk of future interest rate hikes has only become more real.

The Bank of Canada made it clear over the past few months that trade uncertainty was one of the biggest obstacles (alongside the potential of an overheated housing market) keeping it from raising rates more aggressively. The new USMCA should, therefore, give the central bank a bit more comfort and raises the prospect of another 25 basis point rate hike as soon as later this month when its latest decision is announced on October 24.

This wouldn’t necessarily be a huge surprise, but it does set the stage for a potentially more restrictive monetary policy that could become problematic over time and lead to more market volatility along the way.

In the interim, the new trade agreement should provide some relief to investors who have been on tenterhooks from months of tense negotiations between the three countries and, in particular, Canada and the U.S.

While they should expect more noise coming out of the process to ratify the deal by November 30, not enough has changed from the former NAFTA for them to be really concerned. If anything, Canadians may have more reason to boast than their neighbours to the immediate south.

Yes, Canada gave up a little by granting the U.S. more access to the $16-billion domestic dairy market, but only 3.5% of it and the federal government has said it is going to compensate the industry — at least in the short term.

Canada, as well, held the line on maintaining a trade dispute resolution in the new agreement, which U.S. trade negotiators believed was an affront to their country’s sovereignty. At the same time, neither Canada nor Mexico bent on Trump’s demand for a sunset clause that would  have forced all three countries to proactively agree — every five years — that they will remain in the trade pact.

By getting the deal done, Canada also avoided a 25% tariff on automobiles exported to the U.S. This would have hurt Ontario’s economy especially and possibly led to severe job losses in the province.

Kevin McCreadie is president and chief investment officer at AGF Investments Inc. He is a frequent contributor to the AGF Perspectives blog.

Commentaries contained herein are provided as a general source of information based on information available as of Oct 3, 2018 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.

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