A possible shift in US trade policy under President-elect Donald Trump and moves in government bond yields are likely to be the key potential implications of a Trump presidency on Canada's sovereign credit profile, Fitch Ratings says.
Trump's pledge to renegotiate the North American Free Trade Agreement (NAFTA) would have direct consequences for Canada. The US is by far Canada's largest export market, receiving 76% of its exports last year. The Canadian government has indicated a willingness to discuss renegotiation, citing potential benefits for Canada to a review of the trade agreement.
Whether the new administration will view trade with Canada in the same terms as trade with Mexico, which Trump had threatened with large import tariffs during his presidential campaign, is not clear. US trade with Canada, which totaled US$662.7 billion in 2015 according to US government estimates, is broadly balanced, and much of the President-elect's rhetoric has focused on repatriating US jobs. Canada has also seen some manufacturing capacity move to Mexico under NAFTA.
Nevertheless, lengthy renegotiation would create uncertainty and may delay investment in new export capacity that would improve Canada's export performance. Partial reversal of US-Canadian trade liberalisation or disruption to supply chains in areas such as agriculture and auto manufacturing could be negative for Canadian exports and growth. Motor vehicle exports overtook energy as Canada's largest export category in 2015, and autos assembled in Canada and shipped to the US include 63% US-made content.
Energy exports, including oil, gas and electricity, still account for about one-quarter of Canadian exports to the US, and Fitch believes these would be less directly vulnerable to trade restrictions. Trump's promise to authorise the Keystone XL pipeline project would increase Canada's oil export capacity to the US and beyond. If US protectionism were focused on countries other than Canada, this could partly compensate for lost competitiveness versus other countries that export to the US. CAD depreciation has supported non-energy export performance, but the trade deficit is still large. The sharp falls in some emerging market currencies since Trump's election win could negate the benefits of a lower CAD.
As noted when Canada's 'AAA'/Stable sovereign rating was affirmed in August, larger federal deficits have left Canada's debt trajectory more vulnerable to economic shocks or growth underperformance. However, whether a Trump presidency makes such an outcome more or less likely may not be clear for some time.
A second potential source of spillover is via interest rates. The rise in Treasury yields since the election in anticipation of US fiscal stimulus and higher inflation has dragged Canadian government bond yields higher. Canadian 10 year yields have hit their highs for the year this week, although they are still very low by historical standards at around 1.5%.
Higher interest rates would have only a modest impact on the federal budget. In its Fall Economic Statement, the Canadian government estimates that a sustained 100 bp-rise in all interest rates will likely decrease the budget balance by CAN$1 billion (less than 0.1% of GDP) over one year.
However, Canadian mortgage rates are highly correlated with government bond rates and are already rising in response to macro-prudential moves to cool the housing market. Slower growth and rising interest rates could make Canada's high household debt burden less sustainable. Higher risk of housing or financial market stress leading to economic or fiscal underperformance could be negative for Canada's sovereign rating.
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