Macro thoughts – USMCA deal and Italian Budget

Macro thoughts – new USMCA deal and Italian Budget

Morphic’s Head of Macro and Risk Geoff Wood discusses the new trade deal USMCA and the Italian Budget crisis:

What to know about the revamped NAFTA deal

The negotiations for the new NAFTA deal ended last week and Canada joined the deal struck between US and Mexico at the 11^th hour. Here are key takeaways about this trade deal:

• A new name: the USMCA (US-Mexico-Canada Agreement);
• Car industry: 75% of car parts to be made across these 3 counties – which is up from current 62%.
• Labour costs: 30% of work hours must be at or above 16 dollars per hour (headwind for Mexico).
• Unions: New rules around allowing the formation of unions were included (again headwind for Mexico).
• Dairy market: the US gets access to the Canadian dairy market.
• Currency manipulation: Enforceable rules around not allowing deliberate currency weakening are to be noted as this is a sign of things to expect for a potential deal with China.
• IP: Increased IP protections, covers biotech and tech. Sign of things to come for China.

We don’t see this new deal as an auspicious sign for China: Trump appears to be nailing deals with the globe ex-China, isolating and pressuring the Asian country further. Currency manipulation and IP theft sit at the crux of the US dispute with China, a point most likely more important to his eyes than the trade deficit. Largely speaking many of the US global peers, especially Europe, agree with Trump’s stance on China.

Overall, we see limited implications for global markets in the short term as this outcome has already largely been priced.

Italy Budget Crisis

Italy’s first budget under the helm of the populist coalition government of the Northern League and the Five Star Movement was released on Friday. The parties agreed to set Italy’s budget deficit at 2.4% of GDP, a significant increase on the current level.

• No breach of the EU rule: Italy respected the EU’s rule which states that a country cannot run a government budget deficit greater than 3%.
• A 3 year budget deficit announced: This deficit is projected to run for the next 3 years as the coalition government seeks to implement its electoral promises. Additionally, the government appears to be rolling short-term debt out to longer maturities to add some breathing room, should things deteriorate.
• Market’s disappointment: Italy’s Finance Minister Giovanni Tria had guided towards a budget deficit below 2%. Thus, the market was disappointed at the 2.4% announced. The populist parties have pulled rank on their finance minister who was appointed mainly due to his lack of ties to the political parties. The market reacted violently with yields on Italian 10y bonds rising 50 bps and Italian banks down ~10%.

Ultimately the budget is still inside the EU rules and we think the market will let the sleeping dog lie here until escalation with the European Commission or signs of deterioration.