World stocks hit 6-months high as NAFTA overhaul deal soothes trade war fears

World stocks rose to a six-month high on Tuesday, lifted by investor optimism that a U.S.-Mexico deal to overhaul the North American Free Trade Agreement (NAFTA) will go some way to averting a global trade war.

Investors expect Canada too will agree to the new terms to preserve a three-nation pact, while U.S. President Donald Trump and German Chancellor Angela Merkel spoke by telephone and the two leaders “strongly supported ongoing discussions” on trade, according to the White House.

European and Asian shares followed Wall Street’s lead, inching to multi-month highs after the S&P 500 and Nasdaq indexes surged to fresh records on Monday led by gains in technology stocks.

The dollar slipped to a four-week low and implied volatility across currencies and equity markets also eased, as investors took on greater risk appetite. Emerging market stocks hit their highest since Aug. 9.

“Global trade tensions have undoubtedly been the most significant source of risk in 2018,” said Hussein Sayed, chief market strategist at FXTM.

WATCH: What’s next for NAFTA?

6:10 What’s next for NAFTA?

“The U.S.–Mexico deal seemed to boost confidence that the trade war is moving closer to an end, and the next question is who’s next to close a deal with Trump?” he said.

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MSCI’s benchmark world share index followed on from Monday’s best performance in over four months, rising 0.15 per cent, while MSCI’s index of Asia-Pacific shares outside Japan climbed 0.5 per cent.

A pan-European share index rose 0.3 percent for a third straight day of gains. Auto stocks continued to rally, adding 1.3 per cent after enjoying their best day in a month on Monday – German car makers rely on smooth trade between Mexico and the United States to sell Mexican-assembled vehicles into U.S. markets.

However, some analysts were cautious about the rally. Paul Donovan, chief economist at UBS Global Wealth Management, noted markets were assuming already that Canada would join the new U.S.-Mexico deal, but said: “it is not a zero risk process”.

“If Canada does not join, then getting the agreement of (U.S.) Congress will be trickier, as fast-track authorization probably will not hold,” he said.

Tweet This Click to share quote on Twitter: "If Canada does not join, then getting the agreement of (U.S.) Congress will be trickier, as fast-track authorization probably will not hold," he said.

Disputes between the United States and its trading partners have been a drag on investor sentiment for much of the year despite solid economic fundamentals and two robust quarters of corporate earnings.

And the toughest battle in the trade war – with China – still looms. The United States and China held two days of talks last week without a major breakthrough, as another round of tariffs came into effect.

WATCH: Canada reacts to bilateral trade agreement between U.S. and Mexico

1:39 Canada reacts to bilateral trade agreement between U.S. and Mexico

The U.S. Commerce Department also said on Monday that Chinese steel wheels exports were heavily subsidized and that it could impose duties on the product.

Chinese stocks were steady to weaker, though Hong Kong’s Hang Seng index gained 0.6 per cent.

JPMorgan analysts said the trade deal was not necessarily positive for the outcome of talks with China, though they said risks of a generalized global trade war had abated somewhat.

“Despite this, Asia-Pacific equities including HK/China should benefit from the weaker U.S. dollar and risk-on moves,” they added.

The dollar paused near one-month lows against a basket of currencies and the euro was near a one-month top at $1.1680. The greenback’s index has retreated from near 14-month highs and its losses accelerated last week after U.S. Federal Reserve chair Jerome Powell disappointed dollar bulls by signaling only a gradual pace of rate rises.

U.S. economic data – with consumer confidence figures due later in the day and the latest estimate for second-quarter gross domestic product expected on Wednesday – could determine the dollar’s further moves.

But its pullback has offered some respite to battered emerging and commodity-reliant currencies. South Africa’s rand has pulled off two-year lows hit earlier this month <ZAR=D3 while the Australian dollar, often used as a liquid hedge for global growth, is well above recent 1-1/2 year troughs.

There are exceptions, however. The Turkish lira fell another 1.5 per cent against the dollar, adding to Monday’s two per cent fall as concerns have not abated about Turkey’s rift with Washington and its monetary policies.

Italian borrowing costs too rose to three-month highs after Deputy Prime Minister Luigi Di Maio said the country’s public deficit could exceed the European Union’s ceiling of three per cent of gross domestic product next year.