In a relatively quiet week for economic data, except for the UK, we suggested that politics may trump economics. Today, the Canadian dollar is the weakest of the major currencies, losing about 0.5%, while the Mexican peso is the poorest performer among emerging market currencies, losing closer to 1%. The move began last week. Over the past five sessions, the Mexican peso is the weakest currency in the world, losing 2.2% against the US dollar. The Canadian dollar is up 0.1% over the past five sessions that make it the worst of the major currencies.  

The key consideration is NAFTA negotiations. Recall that US President Trump initially threatened to withdraw but was persuaded to negotiate a reformed deal. He preference for bilateral agreements over multilateral agreements seemed an issue of principle.  

There are two ways to read the US demands. The first is from the perspective of “The Art of the Deal” where strong demands are made to forces a favorable compromise. The second is that making unreasonably onerous demands may force a collapse of the agreement that the US President has called among the worst in history. The domestic content proposal and the sunset provisions, as well as other positions, do not seem acceptable to Mexico and Canada at this juncture. The US Chamber of Commerce has come out critical of the White House position.  

Earlier in the negotiations, it seemed like Canada was willing to sacrifice Mexico if needed to preserve a bilateral free-trade agreement with the US. However, some disputes have arisen or intensified, including lumber, dairy, steel, and airplanes, in the US-Canada trade relationship. The Trump Administration is also continuing to threaten to allow the government to shut down in December unless Congress authorizes funding for the controversial wall with Mexico. A collapse of NAFTA would see trade relations revert to WTO rules. Canada and Mexico officials have indicated that they are keen on a bilateral free-trade agreement. 

In any event, the US dollar had fallen against the Canadian dollar from May (almost CAD1.38) to September (nearly CAD1.2020) amid a weaker greenback, and on the signal and delivery of two Bank of Canada rate hikes. As it became clearer that the Bank of Canada was largely interested in taking back the two cuts in 2015, and was not intending an aggressive tightening cycle, and the US dollar recovered more broadly as a December Fed hike seemed more likely, greenback recovered. Bank of Canada Governor Poloz appears to recognize the risks posed by NAFTA negotiations, and this seems to reinforce the cautious stance on monetary policy.  

From early September through early October, the US dollar rose 4.7% against the Canadian dollar. It backed off a little last week but began climbing on the NAFTA developments in the second half of last week. The recent high near CAD1.26 is the immediate target, but beyond that is the CAD1.2725 area, which the 38.2% retracement of the decline since May and the $1.2780 area, the high from August.   

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