Morning Commentary: Addition by Subtraction

Foreign Exchange - Morning Commentary
Addition by Subtraction
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Yesterday, the US Senate passed the USMCA agreement that is now expected to be signed by President Trump sometime next week.  With Mexico already approving the agreement and Canada expected to do so once legislators return at the end of this month, the last remaining step will be implementation.    

From Mexico’s perspective, the deal is a good thing.  However, the benefits of USMCA mainly revolve around preserving the trade benefits of NAFTA rather than any changes from the old agreement.  The elimination of trade risk, that spiked since Trump’s election, is a critical factor as 30% of Mexico’s GDP and 83% of total exports are tied to trade with the US and Canada. 

Additionally, USMCA provides Mexico protection for its automotive industry.  While the new agreement raises the passenger vehicles and light trucks regional content threshold to 75%, it does give a three year transition period.  Significantly, USMCA gives tariff exemptions, under any circumstance, to up to 2.6 million passenger vehicles, all light trucks and $108 billion of Mexican auto parts.  While this could be a limiting factor in the future, this does provide protection for the immediate given current production levels and growth rates.   

USMCA should also help bolster Mexico’s competitiveness through measures that build on NAFTA provisions on corruption and promoting good regulatory practices.  Currently, the 2019 Global Competitiveness Report has Mexico ranked as the second most competitive economy in Latin America behind Chile. 

However, USMCA does inject some uncertainty into the mix.  Unlike NAFTA which had no end date, USMCA will expire in 16 years if it isn’t extended.  6 years in, there will be a panel convened to evaluate an extension that can come at any time before 16 years is up.  Admittedly, NAFTA never had a guarantee that all three countries would remain a part of it, but the explicit deadline in USMCA adds an additional source of uncertainty. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Phil Hogan, the EU’s new trade chief, completed a three day Washington visit yesterday.  While Mr. Hogan expressed a desire to prevent a deterioration in the US-EU relationship, he also categorized President Trump’s tariff threats as short-sighted electioneering and warned Trump about widespread economic damage from protectionism.  On a broader level, this visit is a reminder to the markets that trade issues extend beyond China.  While the Phase 1 deal eases US-China tensions, the escalation of trade tensions with other partners remain a risk.
  • U.K. retail sales had a horrible month with headline retail sales printing -0.6% against expectations for a rise of 0.6%.  A key market theme has been the dovish turn in BoE commentary that raises the possibility of a cut this month if economic performance doesn’t improve.  If anything, data this week has deteriorated and markets have gone from pricing in ~5 bps of cuts last week to ~18 bps of cuts this week.
  • US housing starts beat expectations, printing 1,608k starts against expectations for 1,380k starts.  However, industrial production data disappointed as it fell by 0.3% against expectations for a 0.2% drop. 
  • Chinese GDP data came in on the stronger side with YoY data remaining at 6.0% and QoQ coming in at 1.5%, which was slightly higher than expected.  Additionally, industrial production and retail sales both exceeded expectations.  However, while GDP growth came within the government’s targeted range, year-over-year growth did drop to its lowest level in nearly 3 decades. 
  • Japanese investment outflow data showed a surge in overseas investment demand.  A pick up in outflows was expected as activity dropped during the holiday period, but the magnitude of the increase was unexpected.  Over the past decade, weekly investment outflow data only exceeded the levels seen this month twice, in 2016 and 2018.  Both of those weeks came during Q3 which is typically a strong time of year for investment outflows.  This strong outflow dynamic should continue to provide structural support for USDJPY.  
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