Will A Stick Fight Lead To Bigger Battles?

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From a small regional jet descending toward Vancouver International Airport, global trade looks vigorous. Out the left windows, passengers see huge bulk freighters riding at anchor in the harbor, waiting their turns to load Canadian raw materials destined for mills and construction sites in Asia. Out the opposite windows, vast rafts of logs harvested in the province’s interior fastness bob in the muddy water of the Fraser River awaiting shipment to the US and elsewhere. Between these waters, new construction pushes against the urban rainforest of Stanley Park with giant cranes swinging to and fro like alchemists’ wands turning Asian capital into skyscrapers. In the distance, farmland stretches out south and east like a vast patchwork quilt across the invisible line demarcating Canada from the US.

But though this corner of Canada has grown rich over the past two decades by exporting natural resources while importing human and financial capital, the future of that prosperity looks less certain for reasons that may have implications far beyond western Canada. The US Department of Commerce just recently announced a duty on Canadian softwood lumber imports ranging as high as 24%, with most Canadian lumber producers paying 19.88%. The move echoes the US lumber industry’s claim that Canada subsidizes its lumber exports. The decision also indicates that protectionist sentiment in Washington, DC has shifted from the realm of rhetoric into the realm of action on specific policies, even those pertaining to the nation’s largest trading partner.

Sovereign analyst Nick Tocchio says the imposition of the duty on Canadian lumber risks souring the broader trade relationship between the US and Canada, while also providing a glimpse of how the Trump administration may approach future trade disputes. "This bottom-up, industry-by-industry approach could be the way they go forward, rather than applying a top-down approach with actions such as a border adjustment tax or a complete overhaul of NAFTA."

Softwood lumber appears to provide a convenient opportunity for an administration looking to test an ad hoc approach to protectionism. While NAFTA ostensibly liberalized trade between the US and Canada in 1994, the US maintained restrictions on imports of Canadian lumber until October 2015; hence, this new duty is less disruptive than a similar measure would be for other industries such as energy or automotive where many companies have complex cross-border operations. The lumber industry also has a long history of disputes between the US and Canada; and while British Columbia has previously been able to prove to NAFTA tribunals that it is not guilty of subsidizing lumber exports, the appeal process is lengthy.

The new tariffs imposed by the US will most significantly impact British Columbia, which produces about half of Canadian softwood lumber and whose lumber industry supports around 60,000 jobs.

As Tocchio observes: "The Bank of Canada is already very cautious about trade uncertainty, so they won’t have to refresh their stance following this news. But this confirms that they are right to be wary. Developments such as this might suggest why firms are hesitant to make significant investments in Canada when there is so much uncertainty around trade policy. This supports our view that the Bank of Canada will keep monetary policy on hold into 2018."

Beyond Canada, though, the larger concern for investors is whether the new duty represents merely the latest sniping in an ongoing regional conflict or the first shot in a new trade war to be waged by a more protectionist US administration.

The comments provided herein are a general market overview and do not constitute investment advice, are not predictive of any future market performance, are not provided as a sales or advertising communication, and do not represent an offer to sell or a solicitation of an offer to buy any security.  Similarly, this information is not intended to provide specific advice, recommendations or projected returns of any particular product of Standish Mellon Asset Management Company LLC (Standish).  These views are current as of the date of this communication and are subject to rapid change as economic and market conditions dictate. Though these views may be informed by information from publicly available sources that we believe to be accurate, we can make no representation as to the accuracy of such sources nor the completeness of such information.  Please contact Standish for current information about our views of the economy and the markets.  Portfolio composition is subject to change, and past performance is no indication of future performance.
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