JPMorgan Chase & Co. (JPM) anticipates a brawl between deeply divided U.S. lawmakers over the yet-to-be-ratified United States–Mexico–Canada Agreement (USMCA) that will cause a “weaker for longer” US$0.74 loonie.
The bank is calling for Canada’s currency to retreat to C$1.35 per U.S. dollar by the middle of 2019, revising its previous forecast of C$1.30.
Analysts Daniel Hui and Patrick Locke hold out little hope for bipartisan cooperation in ratifying the new North American trade deal, citing the current tension over the partial U.S. government shutdown as evidence the Democrats and Republicans are unlikely to find compromises.
“This clearly signals that the relationship between the White House and Democrats (now governing the House) is off to a poor start,” they wrote in a research note on Tuesday. “We now believe that NAFTA 2.0/USMCA ratification will prove a lot bumpier than most market participants realize.”
The loonie fell to its lowest level since May 2017 in late December. Stronger oil prices helped lift the currency about 2.6 per cent in January into its current US$0.75 range.
Hui and Locke noted in previous research that they are 70 per cent confident U.S. politicians will finalize the USMCA deal this year. But they give a slim 20 per cent chance of a “swift and straightforward” ratification.
The biggest risk is U.S. President Donald Trump initiating a withdrawal from the current NAFTA agreement as a tactic to force Democrats to accept the new deal, they note.
“Such a scenario, which would trigger a six-month countdown before the actual withdrawal, would create a great degree of uncertainty for industry and financial markets, and would create a Brexit-like cliff-edge,” Hui and Locke wrote. “In our assessment, an activated NAFTA 1.0 withdrawal approval has a 60 per cent probability.”
The bearish loonie forecast is based in part on the expectation that the currency will remain vulnerable to oil “in a way that it hasn’t been the in the past few years,” if prices remain close to the post-2014 crash average of US$46 per barrel.
Hui and Locke add that a more dovish Bank of Canada compared to the U.S. Federal Reserve will also contribute to a growing spread between the loonie and the greenback in the year ahead.
“While it may be that markets gradually reprice some chance of ongoing policy normalization both in the U.S. and in Canada, it is now reasonable to expect US-CA spreads to gradually widen over 2019, like it did over the course of 2018,” they wrote.