The clock is ticking on North American free trade talks, and the City is watching with baited breath. As the deadline for a revised NAFTA agreement approaches, gilt yields have begun to tremble, and capital is already eying the exits. This is Alastair Thorne, and let me tell you: when Washington and Ottawa play chicken with trade deals, the rest of us pay the price in inflation and volatility.
Markets hate uncertainty, and that is precisely what we have now. The three amigos of North America have been locked in a bitter divorce before; we all remember the turmoil of 2018 when steel tariffs sent ripples through global supply chains. This time, it is even more personal. The USMCA, the replacement for NAFTA, is up for review, and the political rhetoric has already sent the Canadian dollar and Mexican peso sliding. But why should London care? Because the pound is caught in a pincer movement between a strong dollar and slowing global trade.
Let us examine the numbers. The FTSE 100, which earns roughly 70% of its revenues overseas, has been buoyed by sterling's weakness. But if the NAFTA talks collapse entirely, we could see a flight to safe havens, with the dollar strengthening further. That would hit our exporters hard, and the Bank of England would be forced to choose between hiking rates to defend the currency or cutting them to stimulate a sagging economy. Neither option is palatable.
Meanwhile, inflation expectations are creeping up. The 10-year breakeven rate, a measure of market inflation expectations, has risen 15 basis points in the past week. This is not a blip; this is a signal. Investors are pricing in higher import costs as tariff walls go up. And who suffers? The consumer. Already, food prices in the UK are rising at their fastest pace in years, and a further escalation in North American trade tensions will only compound this.
And then there is the issue of capital flight. Canadian pension funds have been major investors in London property. If the NAFTA crisis deepens, we may see a repatriation of capital home. That would put further downward pressure on an already shaky commercial real estate market. The frothy valuations we have seen in recent years could come crashing down.
But let us not be alarmist. The most likely outcome is a last-minute deal, a fudge that kicks the can down the road. But the pattern is clear: the era of free trade is over, and protectionism is back in vogue. The bond market is already pricing in this new reality, with the yield curve flattening ominously. A recession is not on the cards yet, but the warning lights are flashing.
So, dear reader, what should you do? Diversify. Look beyond the usual suspects. Australian and New Zealand bonds offer some respite, but even they cannot escape the global tide. And pray that the politicians in Washington, Ottawa, and Mexico City remember that markets punish indecisiveness. Because if they don't, the bottom line will be written in red.
