By Michael O’Neill
The Guardians of the NATO Galaxy, the leaders of the European Union, Germany, France, Great Britain, Canada, and the United States met in Brussels on July 11. These Guardians are nothing like Star-Lord, Gamora, and Rocket Raccoon, but President Trump has plenty of similarities to Thanos. They were gathering under a storm cloud although the threat didn’t come from Russia or even ISIS but from President Trump.
Mr. Trump was angry. He believes NATO members do not live up to their financial commitments and that the US subsidises their defence against Russia and other threats. He took aim at Germany for having a pipeline deal with Germany, tweeting “Germany just started paying Russia, the country they want protection from, Billions of Dollars for their Energy needs coming out of a new pipeline from Russia. Not acceptable!”
The President got results and said so, boasting that because of the pressure he exerted on NATO members, it has resulted in a possible increase of $40 billion in defence spending. President Macron of France denied the claim, saying the leaders just confirmed the defence spending goal of 2% by 2024. It worked with Canada. Prime Minister Trudeau committed Canadian troops to a new training mission in Iraq, obviously, a response to Mr Trump’s earlier letter to NATO leaders demanding that they live up to their funding commitments.
The Guardians of the (Canadian Economic) Galaxy
The Bank of Canada (BoC) governing council are the Guardians of the Canadian Economic galaxy, and they were in action on July 11. The BoC raised the benchmark overnight rate to 1.5% from 1.25% in a widely-telegraphed move. Some market participants were caught off-guard by the tone of the statement. They expected the BoC to acknowledge that elevated trade tensions between the US and China would lower the odds for additional rate increases in the coming months. That didn’t happen. Instead, the BoC, stuck to its guns saying “higher interest rates will be warranted to keep inflation near target.” The Bank’s assessment of the Canadian economy was perky, describing it as “operating close to its capacity” while forecasting Q2 GDP growth of 2.8%. They said the impact of US tariffs on steel and aluminium, while difficult for those industries and their employees, would only have a modest impact on domestic growth and inflation.
Chart: Canada GDP growth forecast
Source: Bank of Canada Monetary Policy Review:
The Monetary Policy Report statement explained why high global trade tensions didn’t play much of a role in the policy deliberations. It said: “The Bank cannot make policy on the basis of hypothetical scenarios. We felt it appropriate to set aside this risk and make policy on the basis of what has been announced.”
The MPR statement did admit that an escalation is the trade war would result in a slowing of the economy, rising interest rates and a weaker currency.
The Bank of Canada may not be able to make monetary policy on hypothetical scenarios, but that’s what trading is all about. Some FX traders seem to believe that the risks from the dissolution of the Nafta, US tariffs on Canadian car imports, and an escalation of the US/China trade skirmish warrant a weaker Canadian dollar. Others are not so sure. They are keying in on the Banks demonstrated insistence that it is data dependent and believe that better than expected domestic data will help insulate the currency from USDCAD gains. USDCAD support is in the 1.3000-50 area with resistance in the 1.3380-1.3450 range.
Guardians of the (international Trade) Galaxy needed
President Trump is relishing his role as a trade negotiator equivalent of Thanos, The Guardians of the Galaxy villain. He told China that if they retaliated to his tariffs on $50 billion worth of imports, he would raise the ante to $200 billion. China ignored him. On Tuesday, the Office of the US Trade Representative accused China of implementing tariffs “without any international legal basis or justification” and said the President ordered “10% tariffs on an additional $200 billion of Chinese imports.” Those tariffs need to jump many hurdles and are not expected to be implemented before August 31.
Are the tariffs for real or is it just a negotiating tactic? President Trump has proved he will follow up threats with action. He did it with the first round of China tariffs; he did when the US hit Canada with tariffs on steel, aluminium, and softwood lumber, and again when he pulled the US out of the Paris Climate Accord.
Prudent Canadian corporations, fund managers or anyone who needs to sell Canadian dollars for US dollars would be wise to hedge or partially hedge their exposures. There aren’t any real-life Guardians of the Galaxy that will save the Canadian dollar from free-falling because of a trade war particularly if the US hits Canada with car export tariffs.