Daily Points

ON DECK FOR TUESDAY, FEBRUARY 4

KEY POINTS:

• Markets take China’s modest retaliation largely in stride
• USDCAD and USDMXN shake off tariffs, for now
• Volatile market slashes BoC rate cut expectations
• Retaliation, performative actions, and industry pushed Trump off his tariff threat…
• …while he signalled an unrealistic timeline for CUSMA/USMCA negotiations…
• …that will keep trade tensions high
• Why Mexico took a different approach than Canada
• The damage has been done to all three NAFTA countries’ economies and relations
• Why investment and productivity will suffer
• US vehicle sales fell, leaning against tariff frontrunning thesis
• US JOLTS, factory orders, Fed-speak on tap

Equities are wavering a touch but generally shaking off mild dips earlier this morning and turning little changed now. Oil is down a buck or so, and sovereign yields have a slight cheapening bias. All of which is a relatively mild reaction to a relatively mild counter punch from China against Trump’s additional 10% tariff and the fact Trump caved on tariffs against Canada and Mexico.

In exchange for Canada offering some silly, minor performative tweaks to the initial border plan that was presented weeks ago, Trump postponed the application of tariffs on Canada for “at least 30 days” according to PM Trudeau, but this conflicted with Trump’s firm “30 day period.” And there’s a huge catch that I’ll come back to. USDCAD and USDMXN have rallied back to being a little firmer than Friday’s close after riding a wild rollercoaster ride yesterday that ultimately saw tariffs postponed.

BoC rate cut pricing for the March meeting was initially cut in half and is now around two-thirds of a cut priced versus more than a full quarter point cut that had been priced. A full quarter point cut has been wiped out for this year that now has markets thinking maybe two 25bps cuts. Shops that hastily rewrote their BoC forecasts on the fly on Sunday are looking rather foolish now. This US President is so wildly erratic and irresponsible that changing forecasts in response to his every social media post, threat and rant risks major forecast revisions by the day.

I’ll argue later in this note that Canada’s retaliation and some silly performative measures worked in getting Trump to back down, but that much bigger risks and high volatility are ahead. Even the WSJ agrees that Trump did a mistake picking this fight and desperately need an out (here).

What China Did

So what did China do? Effective February 10^th, China added a 15% tariff on just under $5 billion of US energy imports and a 10% tariff on US oil and agricultural equipment. There are also some measures applied at individual US companies like Google, PVH, and Illumina, plus a few new export controls on some critical metals. Meh! I guess that makes a point, saves some face for China, makes it clear that the country intends to stand its ground, but it doesn’t much matter in any truly material sense.

Light US Developments on Deck

US JOLTS and factory orders—both at 10amET—may offer light data risk into the N.A. session. US vehicle sales in January were 15.6 million SAAR (16.0 consensus, Scotia 15.5) for a -7.2% m/m SA drop, suggesting that it wasn't tariff front running so much as hurricane replacement demand and fundamentals. We’ll also hear from a few more Fed officials including Bostic again (11amET), Daly (2pmET) and Jefferson (7:30pmET).

What Canada Did

First, here’s what Canada did yesterday to give Trump an off ramp on his unglued tariff tantrum. It offered the same $1.3 billion price tag behind the border plan that was presented weeks ago.

Added to this are 10,000 “frontline personnel” to “protect” the border. Note that it doesn’t say the army, perhaps because the limited army of somewhere around 70,000 personnel and 30k reservists doesn’t have the capacity. Perhaps also because militarizing the Canada-US border to be like the Korean border would be a damn shame between allies.

So think of it as being like 10,000 Walmart greeters, handing out flyers to new arrivals while encouraging them to look around and making sure they don’t steal anything while we check them out. Perhaps spaced a little tighter than one kilometer apart from one another along the length of the Canada-US border; or clustered further apart if they’re fast runners with a plentiful supply of energy drinks. Playing with drones all day, going for sightseeing tours in whirlybirds. Good heavens they’re going to be the most disengaged, bored employees of all time with little to do! A whole new class of bureaucracy created to appease Trump and with the bill footed by you and I, as if we needed more idle civil servants.

Perhaps as bored as said Walmart greeters will be a new Fentanyl Czar and his/her staff. This should be good.

These are all very much performative stunts to entertain the King and provide him with reason to buckle under pressure from industry without completely losing face—which he did anyway in my opinion—but it’s a small price to pay to avoid economic war—for now.

Provinces also started to roll back their measures. Ontario suspended its retaliatory measures as a result including suspending its Starlink cancellation and suspending the removal of US alcohol from the market which other provinces are also doing. I swear the worst job in the world for two days was the LCBO stockboy. ‘Ahhh man, I just finished taking them all off the shelves!’

So it’s good news for now. Trump’s 27-year-old court jester—until he gets bored of her—claims that “Canada is bending the knee, just like Mexico.” Nice try. This interpretation is clearly incorrect, but that’s ok, she’ll be replaced soon enough and left with no scruples to move on with. Canada will be hiring greeters though.

Canada’s Approach Worked & Why Mexico Took a Different Path

I believe that Canada’s retaliatory tariffs and these performative stunts worked. Trump got severe blowback from American industry on the consequences to his tariffs and needed an out, so if thousands of folks standing around doing nothing all day is what it took to allow his erratic ways to have an off-ramp, then so be it. For now, retaliation worked as it made it very clear to the US that Canada isn’t just going to be a pushover. Canada cut a small blackmail check for a fabricated problem at the Canada-US border, and on we march.

But Mexico didn’t retaliate, you say, and yet they got a 30-day delay too so what gives? Does that prove that Canada didn’t need to retaliate? Not for one second. For one thing, the borders are incomparable. The strategies to deal with Trump’s tariffs are similarly incomparable.

Mexico has a very serious border issue with fentanyl and migrants. Can you imagine had President Sheinbaum said ‘nope, it’s all made up, here’s 25% back at ya Trump!’ The US administration would have been incredulous. Mexico took a different root because it knows deep down that it has a problem. A shared problem in that decades of US domestic policy failures around managing its own border and a multi-decade drug problem have gotten the US to where it is today. But a problem nonetheless.

Further, I believe that Mexico was a free rider on Canada’s retaliation, China’s threatened retaliation that came through overnight, and Europe’s threat to counter anything that Trump does with them. American industry cried foul at the NAFTA/CUSMA/USMCA consequences and Trump buckled. Trump thought other countries would quiver in fear and roll over and they did not, benefitting Mexico’s approach.

Further, Mexico did initially threaten retaliation through tariff and non tariff measures on Saturday. Barring agreement, it might well have gone ahead.

Damage Done

But the damage has been done by Trump and it’s not over by any means.

Measures of US trade policy uncertainty have soared back to 2018–19 levels (chart 1). This carries a knock-on cost on confidence. C-suites won't know how to invest in this climate when the trade and investment rules of the game are being irresponsibly toyed with. C-suites considering investing in multimillion or multibillion dollar capex projects have got to have less confidence to pursue them now because they don’t know how erratically the rules of the game may change. The last time we went through NAFTA renegotiations over the 2017–18 period, US cap-ex—measured by core durable goods orders that exclude aircraft and defence—moved lower even before the pandemic struck (chart 2).

C-suites thinking of complementary hiring plans to go with their investment and expansion plans suddenly have less confidence to hire to go with those weakened capex plans, but there’s a catch. The catch is that there could be a repeat of what wouldn’t be good for productivity by biasing the capital to labour ratio in meeting production plans more toward labour because it’s easier to fire workers than unwind capex projects if developments turn sour.

Next Steps

Most important of all is the way Trump ended his social media post; I’ll share the original text from both at the end of this note. He said the tariffs “will be paused for a 30 day period to see whether or not a final Economic deal with Canada can be structured.” Read that carefully. I think it means onward we go into CUSMA/USMCA talks with Trump setting the same wildly unrealistic timeline he did the last time. Trump will push for a rapid deal, and when Canada digs in on important issues, he may well threaten tariffs again. Or maybe the next issue will be to push for ridiculous 5% of NGDP demands on defence spending and threaten tariffs on that too.

Canada still has to be firm throughout it all and play the long game. Take the short-term cost to avoid being pushed into a bad deal for the long-term. Trump will cave into midterms like he did the last time and sign the next 'greatest, bestest, 'uuugest, said-it-couldn't-be-done-and-I-did-it, never seen before, most fabulous deal in history' that may very well change little all over again. Throughout it all, whippy markets and high uncertainty will prevail and that carries a real, tangible cost to the economy and markets. All of which is to say that Canada-US trade uncertainty has only just begun.

Another consequence to all of this is that Trump's power over Europe is severely dented. They'll just scoff at his threat, open a chequebook, and say ok, cut the crap, how much do you want because you know we’re going to retaliate? There is no ‘art of the deal’ beyond the murky world of bullying town councils into granting casino permits. Sovereigns are a different game. Trump learned his latest lesson on that count over the weekend and it took Canada to teach it to him.

Exactly What Trudeau and Trump Said

As promised, here is PM Trudeau’s full quote:

"I just had a good call with President Trump. Canada is implementing our $1.3 billion border plan — reinforcing the border with new choppers, technology and personnel, enhanced coordination with our American partners, and increased resources to stop the flow of fentanyl. Nearly 10,000 frontline personnel are and will be working on protecting the border. In addition, Canada is making new commitments to appoint a Fentanyl Czar, we will list cartels as terrorists, ensure 24/7 eyes on the border, launch a Canada- U.S. Joint Strike Force to combat organized crime, fentanyl and money laundering. I have also signed a new intelligence directive on organized crime and fentanyl and we will be backing it with $200 million. Proposed tariffs will be paused for at least 30 days while we work together."

Now compare that to President Trump’s full quote with emphasis added:

“Canada has agreed to ensure we have a secure northern Northern Border, and to finally end the deadly scourge of drugs like Fentanyl that have been pouring into our Country, killing hundreds of thousands of Americans, while destroying their families and communities all across our country. Canada will implement their $1.3 Billion Border plan, and as per Prime Minister Trudeau, will be, “reinforcing the border with new choppers, technology and personnel, enhanced coordination with our American partners, and increased resources to stop the flow of fentanyl. Nearly 10,000 frontline personnel are, and will be, working on protecting the Border. In addition, Canada is making new commitments to appoint a Fentanyl Czar, we will list cartels as terrorists, ensure 24/7 eyes on the Border, launch a Canada-U.S. Joint Strike Force to combat organized crime, fentanyl and money laundering. I have also signed a new intelligence directive on organized crime and fentanyl, and we will be backing it with $200 million.” As President, it is my responsibility to ensure the safety of ALL Americans, and I am doing just that. I am very pleased with this initial outcome, and the Tariffs announced on Saturday will be paused for a 30 day period to see whether or not a final Economic deal with Canada can be structured. FAIRNESS FOR ALL!”