By Michael O’Neill
“Say Cheese”! US Trade Representative Robert Lighthizer, Canadian Foreign Minister Chrystia Freeland and more than likely President Donald Trump will be smiling brightly for photographers when they announce a new version of Nafta. (NAFTA 2.0)
The people not smiling will be the Canadian dairy cartel. The big three dairy companies in Canada are Saputo Inc, Agropur Dairy Cooperative, (private company) and Parmalat Canada, a wholly owned subsidiary of Parmalat SpA of Italy. They have a combined market capitalization of around $28.0 billion They are very vocal at defending their interests, and their main interests are keeping Canada ’s supply management system in place.
In a nutshell, supply management is a system that allows specific industries (dairy, poultry and eggs) to manage the supply of their products to ensure predictable and stable prices.
According to the Globe and Mail, supply management is used by the Canadian government to support farmer’s incomes without having to write cheques. The dairy boards limit supply domestically while the government limits imports of dairy products, by imposing tariffs of as much as 275%. It also limits competition, hence the big three dairy producers’ interest. The Globe cited facts from the Canada West Foundation that said the average dairy farm had an average net worth of $4.0 million which raises questions about why consumers are subsidizing them.
President Trump is apoplectic about the Canadian dairy tariffs, and the Canadian government is just as stubborn about keeping them.
At first glance, 275% tariffs seem a tad outrageous. And maybe they are, but the issue is also about protecting the Canadian market from the excess of America. Paul Hunter of CBC news wrote last April that Wisconsin has more dairy cows than all of Canada. Their problem is over-production and the US government subsidies them through the United States Department of Agriculture Margin Protection Program for Dairy. Farm subsidy and supply boards serve the same purpose.
What are we fighting for? The entire Canada/US dairy trade accounts for less than 1% of the $871.0 billion trade between the two countries. It seems ludicrous that such a small part of the bilateral trade could jeopardize the entire cross border volumes.
The reason is politics. President Trump has blown the dairy tariffs out of proportion. He needs concessions (or the appearance of concessions) to save face and declare himself the “champion of American Workers.” Prime Minister Trudeau is just as stubbornly insisting that getting rid of supply management is “not acceptable to us.”
More than likely, a deal will be done, and both Trump and Trudeau will be able to say they won.
The Canadian dollar reacted like a deal was imminent. USDCAD dropped from 1.3100 on August 23 to 1.2890 on August 28. Short-term currency speculators piled into Canadian dollars in anticipation of better than expected Canadian Q2 GDP data and positive news on the trade talk front. They struck out on both counts on August 30. The US/CAD trade negotiators agreed not to negotiate in the press, and Q2 GDP rose 2.9%, not the 3.0% that was expected. USDCAD soared and touched 1.2997.
The rally wasn’t just a result of the domestic data or the lack of trade news but because of a broad, somewhat mild shift into risk aversion trades triggered by emerging market currency turmoil. The Turkish lira dropped over 4.5%, and Argentina was forced to raise rates to 60% to stem a free-fall in the peso.
However, there is still a lot of room for a Canadian dollar rally when (if) a trade deal is announced. Market participants have been reluctant to buy Canadian dollars at current levels (1.2980) because of the mercurial temperament of the US President. His negotiating tactics are somewhat crude and his language inflammatory. His apparent willingness to walk away from a deal has limited Canadian dollar gains.
Mexico and the US are under a time constraint. The American’s need 90 days to get the agreement through Congress. Mexico President Enrique Nieto’s term is over on December 1. Both parties want to put this issue to rest and declare victory. With Canada on board, it is icing on the cake but Canada is not a requirement.
A signed deal would send the Canadian dollar soaring, in part because it lifts a veil of uncertainty and improves the economic clarity for the BoC. Governor Stephen Poloz delayed one rate hike this year because of trade uncertainty, and although he insists that monetary policy is data dependent, he would be hard-pressed to raise interest rates again if the deal deadline passed without an agreement and Trump puts 25% tariffs Canadian car imports. An agreement leaves the door slightly ajar for a September 5 rate hike, but wide open for an October move.
The US and Canada trade negotiators won’t be the only ones smiling. FX traders, tired of the volatile price swings, in holiday-thinned markets, will be glad to see the end of the summer holidays and a return to improved liquidity, top-tier data, and central bank guidance.