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Briefing highlights

  • BMO warns non-NAFTA nations
  • Odds rising that NAFTA will fail
  • Markets at a glance
  • Morneau prepares for fiscal update
  • What to expect from Bank of Canada
  • It’s a huge week for corporate earnings
  • What else to watch for this week

As negotiations over the North American free-trade agreement sour, Bank of Montreal has a warning for non-NAFTA nations: They're coming for you next.

And that may happen sooner rather than later as American trade issues rise to the fore this week and into next month.

"The strident U.S. stance may all be bluster, aimed at extracting maximum concessions from its two smaller trading partners, but there is no doubting the seriousness of the administration's protectionist leanings and the dark outlook for NAFTA," said BMO chief economist Douglas Porter.

"And lest the rest of the world think this is just Mexico and Canada's problem, we would remind that these two account for barely 10 per cent of the U.S. trade deficit," he added in a report on the NAFTA talks, where U.S. Trade Representative Robert Lighthizer accused the Canadians and Mexicans of being intransigent.

"One would have to believe that the administration is coming for those responsible for the other 90 per cent of the gap next."

We may learn more this week, given that a big U.S. report on World Trade Organization infractions is expected by Thursday.

Mr. Trump also heads to Asia next month, where he'll no doubt talk trade, among other things.

The U.S. has been adamant about reducing trade deficits. And while Mexico is certainly well up the list, so, too, are China, Japan, Germany, Ireland and Italy. So there are many targets for the U.S. administration.

"Despite continuing to demur from the currency manipulation issue, China will remain a priority medium-term target of the administration's activist trade policy," said currency strategists at JPMorgan Chase.

"Not just is China responsible for an overwhelming share of the US trade deficit … but a recent speech and discussion with USTR Lighthizer underscored how the administration still views China as the primary trade relationship the US intends to address and reorder .

In mid-November, the next round of NAFTA negotiations are scheduled to take place in Mexico City.

United States Trade Representative Robert Lighthizer, centre, with Canadian Minister of Foreign Affairs Chrystia Freeland, left, and Mexico’s Secretary of Economy Ildefonso Guajardo Villarreal, speaks during the conclusion of the fourth round of NAFTA negotiations, in Washington on Oct. 17, 2017

That the NAFTA negotiations are tough should be no surprise. Mr. Lighthizer is doing exactly what Mr. Trump pledged to do, and clearly taking a hard line in negotiations.

Even then, we still don't know whether the American team "is exercising aggressive negotiation tactics, or displaying ideological inflexibility," said currency strategists at JPMorgan Chase.

"But what has become clear, with the announcement to an extension and slowing of the negotiations, is that the threat to trade disruption was not an acute risk this past week," they said.

That's the good news.

"The bad news is that there is open tension between the parties, the discussions are replete with 'significant conceptual differences,' and many of the U.S. demands have been deemed non-starters by Canada and Mexico," said BMO's Mr. Porter.

"By all accounts, what we have here is a failure to negotiate in good faith."

Asked whether he was referring to the U.S., Mr. Porter said: "Well, yes, although the U.S. Trade Rep seemed to be accusing Canada and Mexico of the same."

As Mr. Porter noted, the U.S. current account deficit is "right in line" with its three-decade average and "by almost any measure, poses no serious threat to the economy."

Remember, too, that Canada has fairly balanced trade with its biggest partner, and that the Americans desperately want so much of what we export to them: Oil.

Canada and Mexico, particularly the former, account for a small part of that shortfall, even though they represent more than 30 per cent of all trade flows with the U.S., BMO noted.

"In fact, over the past four quarters, trade in goods and services between Canada and America has been almost precisely balanced; the 'huge' imbalance was US$246-million, or 0.001 per cent of U.S. GDP," Mr. Porter said.

"Put another way, the Canada/U.S. imbalance represents seven minutes of output from the U.S. economy in any given year (i.e., a short coffee break)," he added.

Odds on NAFTA

The odds against a renewed NAFTA are rising, given the hostility evident in the last round.

"We had assumed that common sense would prevail and that some type of modernized NAFTA deal would eventually emerge," said David Madani, senior Canada economist at Capital Economics.

"But this now looks like wishful thinking."

Indeed, observers are revising the possibility of the talks collapsing. Higher.

Elsa Lignos, Royal Bank of Canada's global head of foreign exchange strategy in London, now looks at it this way:

1: The "lower likelihood" first scenario of a NAFTA 2.0: "It is hard to imagine President Trump signing a new NAFTA that is no less protectionist than the current treaty."

2: The "medium likelihood" of talks just plodding on through political developments such as Mexico's mid-2018 election: "There would be moments of drama but markets would get used to fading them quickly, as they do with Trump's threats on North Korea."

3: The "higher likelihood" of talks collapsing: "We see a higher risk that Trump acts before his current Trade Promotion Authority (TPA) expires in July 2018 … While legal challenges and Congress may prevent that from leading to a complete disbanding of NAFTA, markets are not priced for this uncertainty, in our view."

The TPA gives a president the authority to strike trade agreements. The current version runs out next summer without a renewal from Congress, and pro-trade politicians could block that, Ms. Lignos noted.

"The timing of TPA expiry is important as it may spur action by the Trump administration ahead of the July deadline," she said.

"Without TPA the president loses the mandate to negotiate new deals but also to withdraw from existing deals."

Citigroup has also redrawn the outlook, though still sees NAFTA succeeding.

"The probability of NAFTA renegotiations disintegrating and the dissolution of the agreement entirely has risen," said Sergio Luna of Citi Research.

"Nonetheless, we continue to assign the greater probability (70 per cent) to the outcome where NAFTA remains in place and is made incrementally better amid the renegotiation process."

NAFTA outcome probability tree

NAFTA outcomes

25%

Easy passage

30%

Negotiations end badly

45%

Rough road,

but easy passage

27%

U.S. exits

1.5%

Canada or Mexico exit

1.5%

Status quo

25.7%

Canada and Mexico stay

1.4%

U.S. exits

1.3%

Canada and/or Mexico exit

0.1%

U.S. stays with remaining partner

THE GLOBE AND MAIL, SOURCE: CITI RESEARCH

NAFTA outcome probability tree

NAFTA outcomes

25%

Easy passage

30%

Negotiations end badly

45%

Rough road,

but easy passage

27%

U.S. exits

1.5%

Canada or Mexico exit

1.5%

Status quo

25.7%

Canada and Mexico stay

1.3%

Canada and/or Mexico exit

1.4%

U.S. exits

0.1%

U.S. stays with remaining partner

THE GLOBE AND MAIL, SOURCE: CITI RESEARCH

NAFTA outcome probability tree

NAFTA outcomes

25%

Easy passage

45%

Rough road,

but easy passage

30%

Negotiations end badly

27%

U.S. exits

1.5%

Canada or Mexico exit

1.5%

Status quo

25.7%

Canada and Mexico stay

1.3%

Canada and/or Mexico exit

1.4%

U.S. exits

0.1%

U.S. stays with remaining partner

THE GLOBE AND MAIL, SOURCE: CITI RESEARCH

Here's are Citi's three scenarios, based on "what an advocate or a critic might say" after the latest round of talks:

1: The three countries strike a new deal by early next year, and approval is fast-tracked in the U.S.

2: The strongest probability: A deal is struck by mid-2018, followed by a "time out" and then approval.

3: Collapse as "one or more parties" call it quits: "We note that this does not automatically trigger dissolution of the agreement, and that NAFTA would remain in place unless two parties withdraw from the agreement."

Markets believe there's a 30-per-cent chance of NAFTA being killed, but "we believe the likelihood is lower," Mr. Luna said.

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Markets at a glance


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What to watch for this week

It's a big week for Canadian policy makers.

First up is Finance Minister Bill Morneau, with a fiscal update on Tuesday. He'll be followed Wednesday by Bank of Canada governor Stephen Poloz, senior deputy Carolyn Wilkins and their colleagues with a rate decision and fresh outlook.

Where Mr. Morneau is concerned, observers wonder whether the better-than-expected fiscal showing will prompt the government to spend or save.

"In fact, the government has scope to trim the projected deficit by $10-billion in the current fiscal year, and to lower cumulative deficits by nearly $50-billion over the projection horizon," said RBC economist Josh Nye.

"The big question is whether the government will choose to spend some, or all, of this fiscal dividend," he added.

"We think it should exercise restraint. A return to smaller deficits or even a balanced budget would be a welcome development – particularly at this point in the business cycle when the economy is near full capacity and the government should be using higher revenues to create some fiscal room ahead of any economic downturn."

As for the central bank, it's expected to hold its key overnight rate steady at 1 per cent, already having raised it twice.

Along with the decision comes a monetary policy report that should highlight revisions to economic growth forecasts.

"The statement will likely highlight that domestic growth momentum is slowing as expected, while the 'synchronous' global expansion continues, consistent with the recent data," said Benjamin Reitzes, BMO's Canadian rates and macro strategist.

"The monetary policy report will see some meaningful changes to the growth outlook as Q2 GDP was well above the bank's expectations," he added.

"That will prompt 2017 to be revised up to about 3.1 per cent, which will match the best pace since 2005. Despite that upgrade, the projection for Q3 GDP is expected to hold steady at 2 per cent, while Q4 will likely be introduced at a similar level. "

Key for the markets, too, is the fact that it's a huge week for quarterly corporate results.

"In the first half of 2017, S&P 500 operating earnings rebounded 20 per cent year over year, the strongest growth since the economy was emerging from the financial crisis in 2010," said BMO senior economist Robert Kavcic.

"Technology posted its best growth of the cycle, industrial profits have rebounded alongside better [machinery and equipment] investment and a decline in the U.S. dollar since late-2016 has broadly accelerated the upswing," he added.

"With the Q3 reporting period now underway, S&P 500 earnings are expected to rise a tamer 5 per cent year over year, led by energy and technology. Financials, utilities and telecom are the weak spots. [Last] week's results were mixed, with GE and eBay posting notably disappointing results, but we'll be watching how much momentum is sustained as the reporting period unfolds."

The rest of the calendar:

Monday

Earnings galore: Halliburton Co., Hasbro Inc., Kimberly-Clark Corp., Sprint Corp., T-Mobile US Inc., West Fraser Timber Co. and Whirlpool Corp.

Tuesday

Investors will be watching Mr. Morneau's fiscal update, and a raft of earnings: 3M Co., Advanced Micro Devices Inc., AT&T Inc., Canadian National Railway Co., Caterpillar Inc., Eli Lilly and Co., Equifax Inc., General Motors Co., Lockheed Martin Corp., McDonald's Corp., Sherritt International Corp., TD Ameritrade Holding Corp., Tesla Inc. and Texas Instruments Inc.

Wednesday

Along with the Bank of Canada, markets get their first reading of third-quarter economic growth in the U.K., which RBC expects will show "the continuation of sub-par economic growth in 2017." RBC economists believe the economy expanded by 0.2 or 0.3 per cent from the second quarter.

Earnings: Agnico Eagle Mines Ltd., Air Canada, Barrick Gold Corp., Boeing Co., CBRE Group Inc., Freeport-McMoran Copper and Gold Inc., Goldcorp Inc., Lundin Mining Corp., Methanex Corp., Nasdaq Inc., Norfolk Southern Corp., Northrop Grumman Corp., Suncor Energy Inc. and Visa Inc.

Thursday

Markets expect to see details of changes to the European Central Bank's quantitative easing program when the ECB announces its decision.

"Our firm expectation is that announcement will include a reduction of net purchases from January, 2018, onwards," said RBC.

"However, as we have argued for some time now, the length of time the QE program runs for matters more than monthly size," the bank added.

"So while we look for a reduction by at least €30-billion in net terms, possibly even more, to bring net purchases to around €30-billion per month from the current €60-billion, we also expect that the ECB will keep the program open-ended and won't provide a date for when purchases will reach zero."

Earnings: Alphabet Inc., Amazon.com Inc., Baidu Inc., Bristol-Myers Squibb Co., Calfrac Well Services Ltd., Celestica Inc., ConocoPhillips Co., Ford Motor Co., Hershey Co., Husky Energy Inc., Intel Corp., MEG Energy Corp., Maple Leaf Foods Inc., Microsoft Corp., Newmont Mining Corp., Potash Corp. of Saskatchewan, Raytheon Co., Shaw Communications Inc., Teck Resources Ltd., Twitter Inc. and United Parcel Service Inc.

Friday

Expect to see an impact from the vicious storms on the third-quarter GDP reading in the U.S., which economists believe will show an expansion of about 2.5 per cent, annualized, or better.

"Hurricanes will have dented third-quarter GDP," said Royce Mendes of CIBC World Markets.

"But relative to the potential growth rate, Q3 actually won't look all that bad. Household spending was aided by a spike in auto sales related to post-hurricane rebuilding efforts. Net trade also held up relatively well, with export volumes ticking higher while imports stagnated during the period."

Earnings: AbbVie Inc., Cameco Corp., Chevron Corp., Colgate-Palmolive Co., Domtar Corp, Exxon Mobil Corp., Imperial Oil Ltd., Merck & Co., Precision Drilling Corp. and Weyerhaeuser Co.

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