Canada's Besting Mexico in Nafta Talks (If You Trade Currencies)

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Currency traders see the Mexican peso as a clear loser as negotiations over the North American Free Trade Agreement drag on, with the U.S. proposing a clause that could spell the end of the accord.

Implied one-month volatility has been rising for the peso and falling for the Canadian dollar as negotiators proceed with the fourth round of talks to rework the pact, which President Donald Trump has threatened to exit if he can’t get more favorable terms for the U.S.

Mexico is more vulnerable than Canada in part because the U.S. and Canada have a separate trade agreement to fall back on, said Alvise Marino, a strategist at Credit Suisse. Traders in the loonie are also more focused on the prospect of additional rate hikes by the Bank of Canada, he said.

“Mexico would definitely be more directly exposed,” Marino said. “A lot of manufacturing capacity that has left Canada since 2008 has gone to Mexico. It would initially be quite negative in Mexico.”

While Credit Suisse places the odds of negotiations falling through at just 20 percent, the talks have overshadowed an otherwise positive economic growth story in Mexico, Marino said.

The peso has weakened about 6.6 percent against the greenback since discussions kicked off Aug. 16. It dropped as much as 1 percent on Tuesday, after Mexico’s economy minister said the country has the strength to move forward without the trade treaty. The dollar reached 18.9814 pesos Friday, trading above its 200-day average, after U.S. negotiators proposed a so-called “sunset clause” that would see Nafta expire after five years unless the parties can agree to extend it.

Meanwhile, implied volatility in the loonie has moved in the opposite direction. The Bank of Canada has raised rates twice in 2017 and traders are open to the possibility that a third increase this year is in play. The loonie has gained about 1 percent against the U.S. dollar since Nafta negotiations began, and about 8 percent against the peso.

“On the Canada side, Nafta has very much been a side show,” Marino said. “The main story has been the Bank of Canada.”

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