While we believe that optimism regarding an evolving and eventual trade deal between the U.S. and China is well-placed, we would caution investors against growing complacent about trade policy risk more broadly. Other trade actions could weigh on markets and pose a headwind to U.S. economic growth over the next few months.

Potential threat of NAFTA withdrawal

For decades, President Trump has called the North American Free Trade Agreement (NAFTA) one of the “worst trade deals ever made.” More recently, Trump has threatened to withdraw the U.S. from the original NAFTA if Congress fails to ratify the United States–Mexico–Canada Agreement (USMCA), the trade deal that his administration has negotiated to replace NAFTA. This threat may be more than just a negotiating tactic. Here’s why.

House Speaker Pelosi controls whether the USMCA is voted upon, and currently, she has little political incentive to force House Democrats to vote on the agreement as is. For one, House Democrats are wary of handing President Trump a win without significant concessions in return; this reluctance to give the president a political victory is even more acute after the release of the Mueller report, with pockets of Democrats now calling for the president’s impeachment and showing little inclination for bipartisanship. Additionally, Democrats have not been particularly supportive of free trade agreements historically: The original NAFTA only received a minority of support among House Democrats in 1994 (when President Clinton, a Democrat, was in the White House), and subsequent trade agreements, such as the Central American Free Trade Agreement (CAFTA), passed with only a handful of Democrats supporting them.

While the Trump administration says it wants to work with Democrats to address their concerns, the longer negotiations take and the more delayed ratification is, the more impatient Trump may become. Thinking it might accelerate negotiations, he may decide to send notification that the U.S. is withdrawing from NAFTA. Conveniently, notification of withdrawal is non-binding: At the end of the six-month clock, Trump can simply decide not to withdraw the U.S. from NAFTA. In other words, he could get a political headline without actually committing to withdrawal.

Even the notification of withdrawal would be messy, however, as it would almost certainly precipitate a legal fight and create chaos among U.S. companies with entrenched supply chains, which would invariably weigh on markets. In our view, the more delayed the USMCA vote is, the higher the chance of a NAFTA withdrawal notification.

Risk of auto tariffs

While tariffs on autos or auto parts would be exceedingly unpopular with many U.S. stakeholders, including members of Congress and even the U.S. auto companies the tariffs are meant to protect, President Trump’s long-standing focus on this issue should not be underestimated. He has argued about the unfairness of trade terms and the need for tariffs on auto imports since the 1980s.

Additionally, if the past two years are any indication, the president fundamentally believes that the threat – and in some cases, the imposition – of tariffs are effective mechanisms to gain leverage over our trading partners. Similar to how he imposed steel and aluminum tariffs on Canada and Mexico when negotiating the USMCA and tariffs on Chinese goods before entering into negotiations with China, President Trump may move forward with tariffs on European autos as the U.S.–Europe negotiations start in earnest.

May 18 is the current deadline for the White House to act on auto tariffs, but we could see the administration delay that for several months, meaning uncertainty around auto tariffs may continue until autumn.

Learn more of PIMCO’s high-level insights into global trade, geopolitics, and other macro trends in our latest Cyclical Outlook.

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