Skip to main content
Play the Canadian dollar against the peso in NAFTA 2.0, CIBC suggests
Michael Babad

This article was published more than 8 years ago. Some information may no longer be current.

Briefing highlights

  • Loonie to outperform peso: CIBC
  • Global markets at a glance
  • National Bank profit climbs
  • Current account deficit widens
  • ISS opposes Buffett on Home Capital
  • U.S. economic growth revised up

Playing NAFTA

The Canadian dollar may face NAFTA risks. But at least it's not the peso.

Indeed, says Bipan Rai of CIBC World Markets, the loonie could outperform the peso as Canada, Mexico and the United States renegotiate the North American free-trade agreement over the next several months.

"From a market perspective, knowing the differences (and leverage) of each country in the negotiations is key to understanding what [foreign exchange] markets could do under different scenarios," said Mr. Rai, executive director of macro strategy, as he suggested playing the loonie against the peso.

In a recent report, Mr. Rai and his New York colleague Mario Robles, the head of Latin American strategy, gave five scenarios for the loonie outpacing the peso.

1. Mexico will likely "face more challenges" than Canada, specifically in job-heavy industries such as autos. There are other areas, too, like provisions against corruption.

2. "Mexico's political landscape is tumultuous versus the relatively quiet Canadian political scene," with next year's presidential and congressional elections that could put leftist parties in power, affecting energy reform.

3. The Mexican and Canadian central banks are expected to move in opposite directions, with the former ending, and possibly pulling back on, interest rate hikes, and the latter just beginning. The loonie would automatically be more attractive under that scenario.

4. The U.S. takes in 80 per cent of Mexican imports. Which means that "if negotiations were to go wrong, Mexico's external accounts could suffer incredibly."

5. Mexico runs a $56-billion goods and services trade surplus with the U.S., while Canada runs an actual deficit of $12-billion. So "if the U.S. "takes a 'zero-sum' game approach to negotiations aimed at curbing its deficit, then Mexico is more poorly positioned."

CIBC isn't saying that the loonie won't be at the mercy of NAFTA negotiations, but that it's sheltered more than the peso should talks turn sour.

Mr. Rai expects the second round of bargaining, which starts Friday in Mexico City, to be similar to the first, but that markets may get a better sense of where things stand after the third session.

The U.S. dollar is at the mercy of many things, from global developments to the policies of the Trump administration.

So it's hard to project the U.S. dollar's fortunes, which in turn "makes CAD and MXN tricky to play," Mr. Rai said, referring to the Canadian and Mexican currencies by their symbols.

"In light of this, our calculations suggest that it is optimal to play upcoming NAFTA negotiations via the crosses," Mr. Rai said in a recent report.

"In that light, we favour long CAD/MXN as the optimal NAFTA trade going forward," he added.

"That's not just because a trade-obsessed White House knows that Canadian/U.S. trade is far more balanced than U.S./Mexican trade, but also from empirical observations as well. Indeed, a careful study of NAFTA premiums for both Canada and Mexico show that long CAD/MXN is a viable trade in the months ahead."

CIBC ran an interesting exercise on "playing NAFTA," looking at how the Canadian and Mexican currencies performed during certain periods, to help form its recommendation.

For the loonie, the period ran from April 21, when the U.S. slapped tariffs on Canadian softwood lumber, to June 12, when the Bank of Canada caught the markets off guard by signalling higher rates, driving up the currency.

There's a lot that went into their calculations, but Mr. Rai said he and Mr. Robles found that "the 'NAFTA' variable introduced an upward bias to [the U.S. dollar versus the loonie] in that period that was the equivalent of 1.38 per cent above where short-term fair value would dictate it should be."

Having said that, the Canadian dollar was also suffering during that period because of fears related to alternative mortgage lender Home Capital Group Inc., meaning "the NAFTA premium is likely less than 1.38 per cent."

Mr. Rai and Mr. Robles used a different period for the peso, which rose and fell along with Donald Trump's presidential election fortunes given his frequent attacks on Mexico.

Looking at the currencies from the time Mr. Trump appeared to lock up the Republican nomination through to when he began his stint as President, CIBC pegged the premium at about 2.83 per cent.

"Of course, the 'NAFTA' premium model itself doesn't include liquidity, volatility and country premium risk which likely contributed to sensitivity of MXN as well and magnified the effect," Mr. Rai said.

"Still, the results clearly show that if things go wrong – the MXN is more at risk than the CAD."

Read more


Markets at a glance

Read more


National Bank profit climbs

National Bank of Canada posted what it called “excellent results” for the third quarter, with a $40-million jump in third-quarter profit.

Profit climbed to $518-million, or $1.37 a share, diluted, from $478-million or $1.31 a year earlier.



All of its businesses showed “solid performance,” said chief executive officer Louis Vachon, adding that “sustained revenue growth and cost control also contributed.”

Read more


Current account deficit widens

Canada’s current account deficit widened in the second quarter to $16.3-billion, fatter by $3.4-billion because of a bigger shortfall in international goods trade.

The deficit in that trade category grew to $5.2-billion, up $3.3-billion on the heels of a $2-billion hit in the first three months, Statistics Canada said today.

“Although it wasn’t as bad as expected, the widening in the current account deficit during Q2 and only modest help going forward from crude prices, highlight a headwind to further [Canadian dollar] appreciation from here,” said Andrew Grantham of CIBC.




More news

Streetwise

Economic Insight

Inside the Market

In case you missed it