Hot-rodding NAFTA
Donald Trump hammered out a new trade deal with Mexico last week, but negotiations with Canada have been less fruitful.
What does a “good deal” look like? Well, that’s in the eye of the beholder. Canada certainly isn’t convinced by the latest discussions, disagreeing, predictably, over agricultural policies. The US wants its northern neighbour to open up its dairy industry to American farmers, but Canada has a cartel system whose members would instantly sink such a plan (or the government that conceded it). The US can hardly complain, however, it spends about $20bn on farm subsidies each year. It seems unlikely these two nations will be able to come to any arrangement that leaves their extremely powerful agricultural interests any worse off.
Under the terms of the US-Mexico trade treaty to replace NAFTA, 75% of a car’s components will have to be made in the US and Mexico to cross the border duty-free, up from 62.5% under the old agreement. The kicker is that roughly 45% of the components must be made in a high-wage environment ($16/hour). That means either the US will be getting a good slug of the work or Mexican workers will be breaking out the tequila because their average wage is about to shoot skywards from $3 an hour. The latter is perhaps less likely.
Whatever happens, the deal appears to have baked in significantly higher costs to North American car manufacturing. If Mexican workers get a massive pay rise, the deal will be great for them. But that’s a big if. The high-wage clause should mean that US auto workers will secure more work on North American cars in the future. But how well will US-made cars sell if they are substantially more expensive? The end game may be that US workers lose their jobs as their employers get trounced (again) by cheaper, better cars from Europe and Asia. Let’s not forget this happened in the 1980s and then again in the 2000s.
The S&P 500 Automobiles Index is down almost 15% year to date. Higher wage bills are only one of the obstacles on the road. The US President’s stiff tariffs on aluminium and steel have pushed up the cost of raw materials too. Meanwhile Americans are buying fewer cars lately than they have over the last few years. Margins look likely to be squeezed over the next couple of years. And what to do about all those cars bought on effective hire purchase. Most people lease to buy cars these days in that 21st century arrangement that stretches from mobile phones to razors. But a car isn’t a razor. It’s impossible to know how this situation will play out if people decide to quit the regular upgrade scheme for their cars when times get tight. The number of second-hand sales has been creeping up as a percentage of total US car transactions, from 25% in 2010 to 29% in 2017.
But there’s also a chance that this will encourage US and Mexican carmakers to invest more and pay their staff better. Sounds crazy, we know. But European car manufacturers do alright despite paying some of the best salaries in the business. They can do so because of their efficient processes, high levels of automation and frictionless borders within the EU. The US-Mexico deal aims to solve the investment and wage issues, but perhaps it under plays the importance of the frictionless border. A big beautiful wall will play havoc with cross-border supply chains – as will onerous and complicated duty regimes.
Source: FE Analytics, data sterling total return to 31 August
The foggy isle
Everything these days is Trump or Brexit.
Moving on to Brexit, EU negotiator Michel Barnier finally agreed that the bloc would be prepared to offer the UK a special post-split relationship. Sterling jumped 1% on the news. But a few days later Mr Barnier laid out his strong opposition to several planks of UK Prime Minister Theresa May’s Chequers plan. He wants a common rulebook for services and goods, not just goods as outlined by Mrs May. An EU whitepaper estimated that, under the Chequers plan, UK businesses would save about €6bn each year by avoiding services regulations. And so, all the pertinent facts and personas sink back below the surface of the simmering soup that is Brexit until they bubble up again in a couple of weeks or months.
There is zero clarity about Brexit. It seems just as likely that negotiations will continue to roll on for months as it is that Mrs May will simply declare we’re leaving without a deal. Despite this, we believe there is value in setting out a plan of what is most likely and how it will affect investments. To that end, we created a decision tree that may help you arrange your thoughts on the topic.
As for other UK mysteries, Bank of England Governor Mark Carney will appear before the Treasury select committee on Tuesday. After several lingering rumours that he would abandon his post early, Mr Carney has recently intimated that he may want to stay on beyond July 2019. Expect MPs to grill him on this. Brexiteers will be hoping that he doesn’t want to stay on, given his inclination to toll periodic economic Brexit warnings like a gloomy bell. Many investors grumble about Mr Carney’s unreliable policy and guidance too.
But who would take his place if he did move on? Deputy Governor Ben Broadbent is solid, although he is known for putting his foot in his mouth. Andy Haldane, executive director and chief economist of the bank, could be in the running. The financial markets may react well to such an appointment, although he is sometimes seen as too “ivory tower” to make a good central banker. As it is, the frontrunner is actually FCA boss Andrew Bailey.
Bonds
UK 10-Year yield @ 1.43%
US 10-Year yield @ 2.86%
Germany 10-Year yield @ 0.33%
Italy 10-Year yield @ 3.23%
Spain 10-Year yield @ 1.47%
Economic data and companies reporting for week commencing 3 September
Monday 3 September
UK: PMI Manufacturing, BRC Sales Like-For-Like
US: Market Closed for Labour Day
EU: FRA: Manufacturing PMI; GER: Manufacturing PMI; ITA: Manufacturing PMI
Final results: Dechra Pharmaceuticals
Interim results: Air China, Biome Technologies, 21st Century Technology, Gamma Communications, Glenveagh Properties, Microsaic Systems, Tissue Regenix Group
Tuesday 4 September
UK: Construction PMI
US: Wards Total Vehicle Sales, US Manufacturing PMI, Construction Spending, ISM Employment, Prices Paid, New Orders
EU: Producer Price Index
Final results: Craneware, A&J Mucklow Group, Mattioli Woods, Redrow
Interim results: Alfa Financial Software Holdings, Boku, Cairn Homes, Dalata Hotel Group, European Wealth Group, Gulf Marine Services, Inspired Energy, Johnson Service Group, Lighthouse Group, WPP
Trading update: Halfords Group, McColl’s Retail Group, Smith (DS)
Wednesday 5 September
UK: New Car Registrations, Official Reserves Services PMI
US: MBA Mortgage Applications, Trade Balance
EU: Retail Sales, Services PMI; FRA: Services PMI; GER: Services PMI; ITA: Services PMI
Final results: Barratt Developments, Frontier Developments, Haynes Publishing Group, Anpario, Everyman Media Group, Frenkel Topping Group, Location Sciences Group
Trading update: Berkeley Group
Thursday 6 September
US: ADP Employment Change, Initial Jobless Claims, Continuing Claims, Nonfarm Productivity, Unit Labor Costs, Services PMI, Factory Orders, Durable Goods Orders,
EU: GER: Factory Orders, Construction PMI
Final results: Avation, Genus, Go-Ahead Group, Mcbride, Redde
Interim results: Bovis Homes Group, Curtis Banks Group, Deepmatter Group, Hunters Property, Just Group, Melrose Industries
Quarterly results: Dixons Carphone
Friday 7 September
UK: Halifax House Prices, BoE Inflation Report
US: Nonfarm Payrolls, Labor Force Participation, Unemployment Rate, Average Hourly Earnings
EU: Government Expenditure, GDP (Q2); GER: Trade Balance, Industrial Production, Labour Costs
Final results: Ashmore Group
Trading update: Greene King