President Trump announced on Monday that Mexico and the US had reached a trade agreement, temporarily removing the pressure on the Mexican Peso, which had hit a low of 20.96 against the greenback in June. Following the news, the peso rallied against the greenback to reach a level of 18.45, before stabilizing at 19.50 levels. The deal has turned the US dollar temporarily weak as the market now expects a similar agreement to be reached with Canada. As trade uncertainty declined, auto stocks soared, while the S&P 500 and the Nasdaq rallied to record highs.
US-Mexico trade agreement
Discussions between the US, Mexico, and Canada have been dragging on for more than one year, raising concerns of an adverse impact on the 1 trillion dollars annual trade among those nations. During the past month, the US negotiators sidelined Canada and carried out negotiations exclusively with Mexico. Last weekend the negotiators managed to arrive at an understanding on lingering issues that were mainly related to the automotive industry.
Significant changes that would be implemented in the NAFTA agreement are as follows:
- At least 75% of the parts used in each North American vehicle should come from NAFTA countries in order to receive preferential (duty-free) treatment, which will be an increase from the present level of 62.5%.
- Both countries agreed to the condition that 40% to 45% of each vehicle should be manufactured in a factory that pays a minimum of $16 per hour. The US considers this condition as an absolute necessity to prevent further shifting of jobs to Mexico.
- A sunset clause that would trigger a renegotiation of agreement every 16 years has been introduced. The US had been demanding a 5-year sunset clause earlier, and this final decision thus reflects a softening of stand by the US.
- Government procurement rules and dispute resolution mechanisms remain unclear.
Trump wants to finalize an overhauled NAFTA deal by the end of this week and set up a 90-day notice period with the Congress. Political stakes are high for leaders of all the countries involved in NAFTA renegotiations. In the US, mid-term polls are scheduled for November, and Trump wants to make sure voters feel that the US administration is taking steps to protect national interests.
Following the agreement, President Trump tweeted: “A big deal looking good with Mexico!”
On the other hand, Mexico’s President Enrique Pena Nieto wants to finalize an agreement before leaving office in November, and likewise, the Canadian Prime Minister wants to face the October 2019 national election with a renegotiated arrangement in place. With the Mexican contract finalized, the focus now shifts to Canada, and Chrystia Freeland, Canadian Foreign Minister, left for Washington yesterday to begin talks with the US negotiators.
As the uncertainty considerably faded, the market turned jubilant, pushing both the peso and the Canadian dollar to a higher orbit. The rally may be short-lived, however, as the deal severely restrains further investment in the Mexico auto-sector, and in Canada’s case, the issues are additionally complex. Trump wants the Canadian market to open up for the US dairy products, and if not, the US is planning to import duty on vehicles manufactured in Canadian factories.
Trump stated, “I think with Canada, frankly, the easiest we can do is to tariff their cars coming in. It’s a tremendous amount of money, and it’s a very simple negotiation. It could end in one day and we take in a lot of money the following day.”
Trump also wants to split the trilateral NAFTA agreement into two bilateral deals, one with Mexico and the other with Canada. Furthermore, Trump has suggested getting rid of NAFTA name, even though Mexico and Canada prefer no changes to the basic framework. As a result, we expect the rally against the greenback to be short-lived.
Technically, the USDMXN is on a long-term uptrend as indicated by the historical graph provided below. The currency pair is moving along the ascending channel, with strong support at 18.40 levels and we, therefore, expect a bullish reversal of the USDMXN pair soon.
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