One week, U.S. President Donald Trump is touting new tariffs for imports of steel and aluminum. Not long after, his administration is expressing optimism about efforts to renegotiate the North American Free Trade Agreement. What are institutional investors to make of the flurry of activity?
At the beginning of March, Trump announced new tariffs for imports of steel and aluminum, at 25 per cent and 10 per cent, respectively. Days later, he announced Canada and Mexico would be exempt. While the move raised further questions about the trade deal, the situation took another turn this week as negotiators began expressing more optimism about the talks, particularly when it comes to the difficult issue of auto production. According to media reports, the United States has begun softening its stance on U.S. content requirements in vehicles, an issue that has been a key sticking point in the NAFTA talks.
When it comes to the steel and aluminum tariffs, such strong tactics do shake global equity markets, mainly by increasing uncertainty, says Ruo Tan, president of Segal Rogerscasey Canada. “Investors definitely don’t want this rupture . . . so the market reacted very fast and very negatively for two days regarding this particular announcement, especially for the auto industry and aerospace industry.”
While it isn’t the sort of event that could scare Canadian institutional investors out of U.S. equities, the added uncertainty is of increasing concern since foreign equities, particularly U.S. stocks, make up a significant portion of Canadian pension funds’ portfolios, says Tan.
On the other hand, the new tariffs aren’t likely to cause any deep damage to Canadian equities, says David Lafferty, chief market strategist at Natixis Investment Managers. “There’s nothing that jumps off the page that says this is terrible for Canadian equities, in a sense that broad Canadian indexes are sort of dominated by financials and energy.”
Even so, Canadian investors can’t afford to discount the language coming from the Trump administration as just noise, he adds.
“So why do I worry a little bit? Because of the retaliation, these things tend to get out of hand quickly. And so if cooler heads don’t prevail, these things can spiral in a way that the president might potentially lose control of the narrative here.”
Ultimately, it’s important for Canadian investors to try to understand some of the underlying motivations of the Trump administration’s language and actions, says Lafferty. “We can’t be 100 per cent sure of anything. It’s not completely obvious, nor does [Trump] want it to be obvious what the president’s motives are in this — and they’re probably several.”
Trump is fundamentally against free trade, Lafferty notes. “He believes that free trade is sort of the zero sum game, which is not exactly solid economics, but that’s where his core is.”
And if trade friction starts to seep into the services side of trade as opposed to physical goods, Canada may have reason to worry more, he notes.
Further, taking an aggressive stance in NAFTA negotiations may be an effort to strengthen the Trump administration’s negotiating power, says Lafferty. “At a minimum, I think the attempt is to sort of soften the ground for further NAFTA negotiations,” he says. “This puts folks in Canada and Mexico on notice if the president is willing to pull 25 per cent steel tariffs and 10 per cent aluminum tariffs almost out of thin air.”
Finally, the administration’s view that Canada and Mexico have seen more benefits than the United States from NAFTA reflects campaign rhetoric that appeals to Trump’s base of support, says Lafferty. As such, there’s pressure on the president to ratchet up NAFTA threats as the United States approaches its midterm elections to impress districts where the Republican party has been on shakier ground. In terms of his decision-making, Trump is “caught between that populist Midwest in his party and the more pro-business wing of the party,” says Lafferty.
“At this point, it’s a risk scenario, not necessarily something that people should be altering their portfolios around in the near term,” he says. “I think we’re still a long way from knowing when [that] seventh round of NAFTA negotiations get underway in April. I think we’re a long way from knowing if this is sort of going to be a blip on the Canadian screen and potentially on the Mexican economic screen or if this is going to deteriorate between now and then.”
This article originally appeared on our companion publication Benefits Canada.