Canadian Dollar Drops 1.2% Ahead of Trump’s Tariffs

US President Donald Trump’s announcement to impose 25% tariffs on imports from Canada and Mexico starting February 1 shook currency markets late in New York trading. The Canadian dollar and the Mexican peso dropped sharply against the US dollar.

The Mexican peso fell 1.1%, while the Canadian dollar declined by as much as 1.2% after Trump reiterated his commitment to trade restrictions, a promise he had made during his inauguration. The Bloomberg Dollar Spot Index reversed earlier losses to rise by up to 0.2%.

Nathan Thooft, a senior portfolio manager at Manulife Investment Management, noted that the strength of the US dollar remains the default trend as investors wrestle with the ongoing risk of higher tariffs.

Currency traders, operating in the $7.5-trillion-a-day forex market, have been uneasy amid growing fears of increased tariffs targeting not only Canada and Mexico but also other major trade partners.

Trump has hinted at additional tariffs on imports from the European Union and China. While discussing China, he suggested plans to proceed with tariffs but did not specify the exact rate.

Since Trump took office, the dollar has gained significantly, fueled by expectations that tariffs could strengthen the currency, as higher price pressures likely keep US interest rates elevated. The uncertainty around global trade has further bolstered the dollar, with investors seeking safety in the world’s reserve currency.

Canadian Dollar had dropped 6%

Meanwhile, Canadian and Mexican currencies have faced direct consequences from Trump’s tariff threats. According to Bloomberg, the Canadian dollar dropped about 6% against the US dollar in the previous quarter, hitting its lowest point since 2020.

A 25% tariff could push the currency even lower, potentially reaching a two-decade low. Such a move might force the Bank of Canada to slash interest rates more than anticipated, plunging the economy into a deep recession. Some strategists believe the loonie could approach its record low from 2002 if harsh tariffs and retaliatory measures are enacted.

Sarah Ying, head of FX strategy at CIBC Capital Markets, remarked that markets were already preparing for a stronger US dollar against the Canadian dollar, and Trump’s latest announcement only solidifies that outlook. She added that it’s not the right time to go against this trend.

Mexico’s assets have also taken a hit, making the peso one of the hardest-hit emerging market currencies. While it managed to hold steady in January 2024, it was its worst year against the dollar since the global financial crisis.

This decline was fueled by expectations of Trump’s return to the presidency and domestic political challenges. Deutsche Bank economist Francisco Campos estimates that a blanket tariff on Mexico could lead to a 10% drop in the peso’s value against the dollar. He also predicted investors might sell off Mexico’s dollar bonds, while companies reliant on US exports could see their stocks tumble.

Trump repeated his claim that China would bear the burden of tariffs and floated a potential 10% measure against the country shortly after his inauguration. With Chinese markets closed for a holiday, the offshore yuan weakened by roughly 0.4% against the dollar, marking its steepest drop in over a month.

The president’s comments also created ripples in the US bond market. Treasury futures gave up some of their previous gains, while the S&P 500 briefly dipped before recovering to close 0.5% higher. Technology stocks, a sector heavily reliant on international trade, drove the brief downturn as investors reevaluated their positions.

Experts weighed in on the developments:

• Matthew Rowe of Nomura Capital Management warned that the move is inflationary and raises fears of a broader trade conflict that could hurt growth and corporate profitability.
• TD Securities strategist Jayati Bharadwaj observed that while currencies have already been hit, more pain could follow unless key sectors are spared from tariffs.
• Monex foreign exchange trader Helen Given suggested that if Trump continues pushing these tariffs, the Bloomberg Dollar Spot Index could gain 1% by Monday morning.
• Deutsche Bank’s Francisco Campos expects Mexico’s government to respond quickly with policies addressing immigration and fentanyl concerns and predicts retaliatory tariffs will be announced.
• Barclays currency strategist Skylar Montgomery Koning projected that a 25% tariff on Canadian imports could lead to a 19% depreciation of the Canadian dollar against the US dollar, with the currency pair potentially exceeding 1.60.

Market participants closely watch how these tariff plans unfold, as the potential economic and market impact could be significant.

If Trump follows through on his threat, the Canadian economy would be devastated, particularly in Ontario, where auto and part manufacturers are highly integrated with their US counterparts.

The tariffs would be bad for both sides, but the US is better positioned to deal with the disruption to its economy’s size and diversification.

The Bank of Canada cut its benchmark rate by 25 bps to 3.00% yesterday. The statement and press conference will not offer much insight into future monetary policy actions because the tariff threat raises too many questions.

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