A NAFTA by Any Other Name

Surprise! President Trump and Canadian Prime Minister Justin Trudeau struck a last-minute deal Sunday, bringing Canada into the renegotiated NAFTA the US and Mexico shook on in late August. The biggest change is cosmetic: The NAFTA moniker is dead, replaced by US-Mexico-Canada Agreement, or USMCA for short, which seems a little uncreative to us. Naming aside, the new deal looks an awful lot like the old deal, making us chuckle as we reviewed some of the media coverage casting it as a big deal and important aversion of disaster. Now comes the next round of politicking, as some lawmakers have already voiced their opposition to the revised terms. So NAFTA chatter will probably be with us a while longer, though for now, stocks have one less source of uncertainty to deal with.

As best we can tell, the deal has enough tweaks to let everyone involved claim some wins—crucial for Canada, in light of today’s elections in Quebec, and the US ahead of next month’s midterms. Rules of origin for automobiles got a small makeover. USMCA increases the local content requirement from 62.5% to 75% and adds the caveat that 45% of any autos imported duty-free be made by workers earnings $16 per hour or more. While these changes might look big, Bloomberg recently estimated only three models would run afoul of the new rules of origin. If the wage requirements apply to the entire, global production chain, then they too probably won’t bite much, considering most non-USMCA content in cars Mexico exports to the US comes from high-wage Japan, South Korea and Germany. Bloomberg estimates the wage rules would affect only about 25% of US auto imports from Mexico. We suspect it might be even less than this, as the wage floor isn’t indexed to inflation and doesn’t take full effect until 2023. $16 then will likely be less burdensome than $16 today.

Outside the auto industry, the biggest headline grabber came from dairy, as Canada dropped some of its protections against US dairy imports. That was perhaps the most contentious part of the deal, as the dairy bloc holds considerable political sway in Quebec, and upsetting it on the eve of an election could cost Trudeau’s Liberal Party at the polls. In the end, both sides can claim victory. Canada kept most of its restrictions, but it granted US dairy farmers more market share and removed a byzantine pricing system that should open the market to more US infant formula and powdered milk. So, score a tiny win for an industry worth about half a percent of US GDP.

The new e-commerce rules will probably make a bigger splash. The Internet wasn’t much more than a science project when NAFTA was born, so online shopping has long been outside its scope. That changes with USMCA’s e-commerce chapter, a welcome modernization. Canadians can now buy C$150 worth of US goods online duty-free, up from $C20. There is also a new intellectual property chapter improving biotech intellectual property protections, another modernization to accommodate technology’s advances over the past 25 years. Meanwhile, US drug companies get an extra two years of protection from Canadian generics north of the border, and while the steel and aluminum tariffs remain in place for now, talks to end them are under way.

While USMCA includes a couple protections that weren’t in NAFTA, overall, it appears to make trade among the three nations freer, simply by virtue of expanding free trade to areas of the economy that didn’t really exist 25 years ago. It also expands access for financial services firms. USMCA does include the 16-year sunset clause the US sought, which some claim is a negative. And it may be! It isn’t hard to imagine this driving more trade uncertainty down the line. However, it also seems fair to say new economic frontiers will open between now and then, requiring USMCA updates to expand free trade to these areas. If NAFTA had a similar sunset, it is entirely possible e-commerce would have gotten the free-trade treatment eight years ago. So we can see this one both ways. Plus, 16 years is far out of stocks’ typical time horizon. What matters most is that within the next 3 – 30 months or so, trade among the US, Mexico and Canada doesn’t look poised to become radically less free.

That said, this isn’t a done deal yet. Trump, Trudeau and outgoing Mexican President Enrique Peña Nieto are set to sign the treaty on November 30, but from there it goes to each country’s legislature for ratification. Several US lawmakers have already started nit-picking, and both parties appear eager to use it as a wedge issue in midterms. Considering midterms likely increase gridlock, it wouldn’t surprise us if USMCA bounced around Capitol Hill for a while. We doubt it would shock Trump, Trudeau and Peña Nieto either, as their anticipation of political delays appears to be a big reason they set 2020 as the effective date.

So expect more political chatter and threats to torpedo USMCA in the coming months. But for stocks, this is likely a more palatable brand of uncertainty than the existential brand of NAFTA uncertainty that lingered over these negotiations. After all, if Congress doesn’t ratify USMCA, NAFTA remains in place. That is probably a-ok for stocks, which have largely enjoyed NAFTA for a quarter century. Either way, investors can probably plan on having some sort of trade deal, which should be enough to encourage risk-taking.