94.7% FORECAST ACCURACY   ||  BUSINESS-MINDED ECONOMISTS   ||  UNBIASED AND APOLITICAL

ITR Experts Say

Tentative NAFTA Agreement Should Alleviate Uncertainty

By Connor Lokar on October 3, 2018

Free Economic Updates

Back to main Blog
Connor Lokar

As a millennial, Connor brings a new perspective to the world of economics, delivering ITR’s industry-leading accuracy to current C-suite executives while forging connections with the next generation of business leaders.

Over the weekend, the US and Canada were able to work through lingering disagreements on a revised North American Free Trade Agreement (NAFTA). The new NAFTA, to be officially coined the US-Mexico-Canada Agreement (USMCA), still has to clear Congress and will not be signed until late November, but it seems the light at the end of the tunnel is finally in sight. The agreement will take effect in 2020.

The new question: Will the resolution make enough of a difference to stave off business-cycle decline for the US and its North American partners next year?

One of the hardest-to-quantify costs of tariffs and other trade-related disruptions is uncertainty. Sureness of the future and a stable playing field are key ingredients for confident executive decision-making. Stable economic policy goes a long way toward facilitating that stable playing field. Unfortunately, US protectionism has introduced a great unknown into the mix and generated uncertainty at the macro level. On the road over the past year, I have spoken with many executives who have put strategic decisions on hold, taking a wait-and-see approach amid ongoing US trade disputes.

US Industrial Production Index to Economic Policy Uncertainty Index chart

A few comments: Charted here is our benchmark for the US economy, the US Industrial Production Index 12/12 rate-of-change (blue line) versus the 12/12 rate of change (green line) for FRED’s Economic Policy Uncertainty Index, which attempts to quantify relative changes in policy uncertainty. The data has been inverted so that Uncertainty Index movement below the zero-line indicates rising uncertainty.

  • The Uncertainty Index 12/12 has an acceptable correlation of 0.71 to the US Industrial Production Index 12/12, and, while somewhat erratic, is generally effective at predicting turning points in the US economy.
  • The Uncertainty Index leads the US economy through the business cycle by seven months, which suggests that building uncertainty begins to take a toll on the growth rate of the US economy seven months later.
  • While the Uncertainty Index does not have a perfect record of predicting recession, spikes in uncertainty typically do not bode well for the US business cycle.
  • The Uncertainty Index is in a mild declining trend (per the chart inversion), signaling slowing growth in US Industrial Production come 2019.

Given this backdrop, a finalized trade agreement between the US, Canada, and Mexico would inject welcome certainty into an uncertain world and could positively impact the business cycles of the three North American economies next year. If the latest data is any indication, they may need it. The NAFTA Leading Indicator, a composite that aggregates the leading indicators of Canada, Mexico, and the United States, is in a declining trend, and the 1/12 rate-of-change is dangerously close to dipping below zero for the first time since 2016. The NAFTA Leading Indicator 1/12 typically leads US and Canada Industrial Production by 10 months and Mexico Industrial Production by eight months. Its current downward trajectory portends business-cycle decline for all three economies into at least mid-2019.

We will follow the NAFTA Leading Indicator (or is it now the USMCA Leading Indicator?) in the coming months and evaluate whether this announcement moves the needle. If the agreement kickstarts a new rising trend, it could signal a more favorable 2019 for North America. Our ITR Trends Report™. readers and ITR Insiders™ will be the first to know.

Connor Lokar
Economist

The latest insights from our expert economists, delivered right to your inbox.