The bilateral trade deal reached by the United States and Mexico is a positive development for capital markets for three reasons. First, the trade deal removes uncertainty for businesses with supply chains that are dependent upon laissez-faire trade in North America.
Second, it incentivizes Canada to make trade concessions in future negotiations to avoid being omitted from their largest trade market segments. Third, the United States and Mexico reached the agreement before President-elect Andres Manuel Lopez Obrador takes office.
Protectionist trade policies were abandoned decades ago in favor of laissez-faire trade because they often do not work and can leave a nation’s production base worse off.
Allowing trade tariffs to aggrandize would eventually cause global growth to decline, and the United States’ GDP would not be immune from being dragged down along with it.
The centerpiece of the deal revolves around the automobile industry encouraging vehicle production in the United States with added incentives to use domestically produced steel and aluminum in the production process. It’s a sweetener that will produce a tailwind for both of those industries.
This deal gives businesses greater certainty regarding their supply chains and input costs. Most importantly, it allows them to plan for their immediate and long-term future. This should encourage long-term investment, which is the foundation for the equity market to go sustainably higher in the future.
Canada is now under pressure to reach a deal now that two-thirds of North America has a trade agreement in place. The administration is proving that it is serious about cooperating with, and not just fighting with trading partners.
Canada, of course, cannot afford to risk being shut out of the North American market. We can expect them to be more flexible in negotiations, such as regarding U.S. dairy products entering Canada. Hopefully this deal results in a domino effect, with subsequent trade agreements to follow.
Mexico, over time, has gradually accepted capitalism and globalization. President-Elect Andres Manuel Lopez Obrador (AMLO) communicated a very nationalist message during his campaign, including increased social spending and a delay of NAFTA renegotiations.
I believe that Mexico is witnessing the financial problems that a handful of emerging markets are experiencing and wanted to get a deal done. The trade agreement removes uncertainty from the marketplace.
With the Federal Reserve communicating to the market that it will continue to gradually raise interest rates and with the dollar remaining strong, emerging markets will be vulnerable to foreign investor capital flight and the possibility of a currency crisis, which Mexico experienced in 1995.
Getting a trade deal signed was in the interest of both nations and their economies. In Mexico’s case, it acted first in engaging with its largest trading partner, cementing its relationship.
The deal benefits the U.S. by increasing the competitiveness of U.S. labor and removes uncertainty for midwestern farmers, a key political base for the administration.
We can expect the market to move marginally higher as the market prices in each incremental trade deal. This is a nice first step in removing a tit-for-tat trade tariff overhang from the market outlook. That will allow investors and businesses to model and plan for the long term.
For the market to move meaningfully higher, hopefully the world can embrace truly free trade policies that are fair and equal for all participants. If we can ever get to that point, capital markets could certainly reach incredible heights.
Jay Leonard, FRM, CAIA, is a chartered financial analyst and senior vice president at Garwood Securities, a boutique institutional broker-dealer.