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The Canadian Dollar: Bulls Bet on End to "Mexican Sit On" as Bears Fall Silent

Image © White House

- CAD buoyant even in the face of a Monday 'Mexican Sit On'.

- Analysts eye a short-term rally if U.S.-Mexico tariffs are avoided.

- But risk is high, few addressing possible lows if tariffs implemented.

The Canadian Dollar was on its front foot against a weakened U.S. greenback Friday amid high hopes that U.S. tariffs on Mexican goods can be avoided, but the final session of the week will be an important one that could ultimately throw a lifeline to those who're betting against the Loonie.

Financial markets have turned bearish in their view on the Loonie of late, particularly Canadian firms themselves who would presumably understand the challenges facing likely to be faced by the currency up ahead more than their international counterparts.

However, markets also now have an increasingly negative view of the U.S. Dollar, which has helped drive the USD/CAD rate down to a six-week low in recent days, but that could all change soon if Friday's negotiations between the White House and Mexican administration don't pan out the right way.

"US-Mexico talks again ended without agreement and US VP Pence was adamant tariffs will be imposed on Monday. As talks resume today, however, hopes of a delay remain elevated," says Adam Cole, chief FX strategist at RBC Capital Markets.

Vice President Mike Pence told reporters Thursday that talks between the U.S. and Mexico will continue Friday as Mexican officials seek to avert an imminent imposition of tariffs on goods exported to the U.S., which could risk delaying, if-not, scuppering the ratification of the new North American Free Trade Agreement (USMCA).

"In the month of May alone, the American people learned yesterday, 144,000 people were apprehended attempting to cross our southern border," says Vice President Mike Pence. "The time has come for Mexico to do more to stem the tide of illegal immigrants that are making their way north from Central American through Mexico and coming into our country. And the President has taken a strong stand. We’ll continue to take that strong stand until Mexico takes such action as is necessary."

President Donald Trump said last week that from Monday, 10 June a tariff of 5% will be applied to all goods imported into the U.S. from Mexico, citing illegal migration as the reason behind the move. Multiple so-called caravans of migrants have travelled across South America in the past year, through Mexico and up to the U.S. border where they have attempted to gain legal or illegal entry into the country.

Trump has repeatedly called for Mexico to do more to prevent those 'caravans' from passing through its territory and is now threatening new tariffs on imports from Mexico if it doesn't act to stop the flows. Tariffs will rise steadily each month until either they reach 25% or the Mexican government meets Trump's demands for it to prevent migrants travelling across its territory to enter the U.S.

Above: USD/CAD rate shown at daily intervals.

Despite the risk to both Mexico and Canada that stems from the tariffs, the USD/CAD rate has declined 1.13% below 1.3350 in the last week as traders sold the U.S. greenback while holding out hope that the levies could be averted by a last minute agreement that could yet come, but that also might not materialise. The Pound-to-Canadian-Dollar rate has also fallen to new lows beneath 1.70.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

"Markets might welcome the idea of US lawmakers standing up to the risks of an upheaval in US supply chains, or of Mexican authorities going the extra mile to dodge the latest tariff du jour, but seem unwilling to factor in the arguably non-zero possibility that tariffs might not be a means to an end but rather an end of its own for now – as President Trump himself suggested during the joint press conference with Theresa May on 4 June," warns Alvise Marino, a strategist at Credit Suisse.

The tariff threat comes as lawmakers from the U.S., Mexico and Canada step up efforts to ratify the United-States-Mexico-Canada-Agreement (USMCA), which is an updated version of the NAFTA agreement, although that process is now in doubt. Analysts have long said the Canadian Dollar would suffer greatly if the NAFTA, now USMCA, agreement was torn up by the U.S. Tariffs on Mexican goods are becoming likey and would risk exactly that.

However, the U.S. 'Mexican Sit On' as it's been described by some analysts, also comes hard on the heels of the world's largest economy having escalated a tariff fight with its nearest rival, China. That tariff fight now risks morphing into an all-out economic conflict, with company 'blacklists' also being deployed, and has roiled global financial markets repeatedly during the last month.

"The outlook for US-Mexican trade talks is uncertain and tariffs could be hiked on June 10, as threatened. If that happens, risk aversion would return to the markets, and falling stock prices and yields would help the JPY strengthen," says Derek Halpenny, head of research at MUFG.

TD Securities has long been a seller of spikes in the value of the Loonie and CIBC Capital Markets, another Canadian firm, have been betting against the Canadian Dollar in recent months, mostly due to economic reasons but also as a result of expectations the new NAFTA deal might prove difficult to ratify.

"We rather think that the move lower in the USD has been rather impulsive, setting up the risk of some retracement against select currencies like the CAD, EUR and AUD. NZD continues to trade cheap on our FV measure, keeping us content in kiwi dip buying and further topside in NZDCAD," says Mazen Issa, a strategist at TD.

CIBC entered a 'long' USD/CAD position at 1.3475 this year and is looking for a move up to 1.41, which would be the exchange rate's highest level since the early days of 2016 when the prices of the North American country's main export, oil, reached their lowest ebb in the 2014-2016 boom-to-bust turn.

The bank said this week the Loonie could rally sharply over the short-term if the Monday 10, June tariffs are avoided. However, few analysts appear to be contemplating the levels it might reach if the tariffs do come into effect.

"If, hopefully, those threatened tariffs are not imposed, a reduction of trade uncertainties and an improving Canadian growth picture over the summer could lead to a short-term rally in the loonie," says Avery Shenfeld, chief economist at CIBC.

 

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