Trade tariffs – will he, won’t he? USD swings ahead
The desk anticipates significant volatility in the USD as the implementation of a 25% trade tariff on Canada and Mexico looms, a move that could exacerbate market tensions and impact cross-border trade dynamics. Per the full note from MUFG EMEA, the potential for President Trump to proceed with these tariffs could lead to a stronger USD in the short term, particularly against the CAD and MXN. The desk notes that the Federal Reserve's recent policy stance, coupled with the ECB's upcoming decisions, adds further complexity to the FX landscape. With no major events on the calendar in the next month, traders should remain vigilant as market sentiment shifts in response to these developments.
What the desk is arguing
The looming implementation of a 25% trade tariff on Canada and Mexico represents a critical inflection point for USD pairs in the FX market. The anticipation surrounding President Trump's approach to trade policy is likely to induce significant swings in currency valuations, especially against the CAD and MXN.
Moreover, the current week is not just about tariffs; attention is also on the Fed and ECB meetings. The resulting environment could enhance USD strength in the short term, especially if either central bank signals a more hawkish stance, overshadowing potential downside from trade policies.
Where it sits in our coverage
Our consensus target for USD/CAD stands at 1.075, with a firm spread between 1.04 and 1.12. This perspective aligns closely with MUFG's analysis, which anticipates significant currency movements due to tariff implementation and central banking decisions.
In the context of our coverage, notable targets include: - JPMorgan: Target of 1.10 for Mar-26 - Barclays: Target of 1.08 for Mar-26 - Citi: Target of 1.05 for Mar-26
How other firms see it
Goldman Sachs holds an aligned stance, endorsing a more bullish outlook for the USD/CAD in light of anticipated market reactions to tariffs. Conversely, BofA presents a contrary view, advocating for a bearish perspective with a target set at 1.04, suggesting reservations about the tariff's effectiveness impacting the USD positively.
0125% tariffs on Canada and Mexico could drive USD volatility.
02Central bank meetings add layers of complexity to FX dynamics.
03Market positioning anticipates significant swings in response to trade policies.
Market implications
The tariff implementation is expected to heighten Forex market volatility, particularly in USD/CAD and USD/MXN pairs. Traders should prepare for potential sharp movements that could arise from any surprises in monetary policy announcements from the Fed and ECB, which may further influence risk sentiment in the market.
Risks to this view
The primary risks include an escalation in trade tensions that could provoke retaliatory measures from Canada and Mexico, which might adversely impact the USD. Additionally, if the Fed signals unexpectedly dovish shifts, this could undermine the dollar's strength despite tariff influences.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Hale-Henney, Head of Research, Global Markets, EMEA and International Securities. It's Friday 31st of January 2025 and joining Derek to pose some questions to the financial market deans for the week ahead is Jack Greenslade from the Global Customer Marketing Group. The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients.
Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi Derek, how are you? Good Jack, and yourself?
Yeah, I'm very well thanks. End of the week. It is, yeah.
Podcast time always at the end of the week, so it's a good time. Yes, and a new month as well. Hopefully a month closer to a bit of sunshine, longer days, etc.
Exactly. So Derek, tariff man, is he back? I guess there's probably a bit of scepticism after he rolled back on Columbia measures, which maybe explains Cadmex and CMY moves.
But will Donald Trump follow through with the 25% tariffs on Canada and Mexico and the 10% tariffs on China, do you think? Yeah, I think, you know, obviously, as you've alluded to, Jack, price action for DollarCard and DollarMex certainly doesn't suggest investors are fully believing the threat, which, to be honest, at this point in time, I'm a little bit surprised there's not a bit more upside on show as we approach the date for implementation. There's reported schedule executive order signings taking place at 3pm Washington time.
So that's 8pm London time. Obviously, that's very much the tail end of the trading day. So liquidity wise, you would certainly expect not to be great.
And therefore, you know, you could get some potential market swings going into the close. But to answer your question, Jack, you know, at this stage, I think it's likely that we're going to get the announcement. I think there's still an element of uncertainty in terms of what happens exactly after that.
Because this International Emergency Economic Powers Act, if that is what he's going to use, which I think, given the framework of that in terms of the speed in which you can implement it, it seems more likely than not that that is the measure that he would use to implement the tariffs. And he's done this before. He used this against Mexico in 2019 in relation to illegal immigrant borders.
And he announced the tariff on the 30th of May 2019, and an effective date of the 10th of June. And the tariff was 5% as a starter, and then it was going to increase by 5% each month after that. And then, of course, before the 10th of June, it was cancelled because of an agreement that was reached with Mexico.
And I think, you know, there is still a degree of logic in investors thinking that, you know, Trump won't follow through in a plain simple 25% tariff. You know, you're talking about nearly one third of all of US imports coming from Canada and Mexico. So in particular, you know, there's an energy 4 million barrels per day of crude from Canada, huge auto trade over both borders, and then significant agri food imports from Mexico.
So there would be a pretty abrupt price increase. And obviously, given the unpopularity of Biden and Kamala Harris, and why Harris lost the election, it was, of course, the cost of living crisis. So, you know, I think the lateness of where we are, I think it's more likely than not to be announced.
Maybe we can't be sure on the 25% tariff, maybe he'll, although he did reiterate that would be the minimum rate yesterday. So, you know, it looks like it's going to be announced. And then maybe there's an effective period that could allow for some negotiations on it to be reversed.
And I think that's certainly what the markets expect. If it is announced, certainly, you know, we think dollar CAD could be through 150 pretty quickly, dollar max, you know, for certainly over through 21 pretty quickly and, you know, with scope to get up to 22 on that size of tariff. So a lot of price action still to come if he does announce it.
Obviously, how he communicates it and, you know, whether he's open for negotiation and all of that will impact price action on Monday as well. But certainly, given the limited news we've had so far, I think that's what you'd expect for dollar CAD and dollar max. And of course, for the dollar more broadly, because obviously, it's an indication of what he could do elsewhere.
I think the effective date for China, I'm not sure if that's specifically linked to that, but it's 10% versus 25 for Canada and Mexico. And, you know, we've had a move higher in dollar CMY already. So for CMY, it's a bit more reasonably priced than obviously, for CAD and max.
Obviously, you said, you know, you expect dollar CAD could potentially trade a little bit higher. Do you think that that's also on the back of the Bank of Canada meeting we had this week as well, perhaps in being a little more dovish than initially expected? Yeah, yeah.
You know, I think certainly, they are open for doing more. The guidance was pretty clear on that. In terms of the actual cut itself, obviously, that was fully expected.
I think what was very clear from Governor Macklem is that when it comes to tariffs, in terms of is it an inflation risk, or is it a demand shock? There's elements of both, of course. But for Canada, it was very clear that the Bank of Canada's concern would be on the demand shock.
And he stressed that the scope for them to cut a lot more to try and counter that. So I think we're pretty clear in terms of how the Bank of Canada would respond. Yeah, of course, they weren't the only central meetings we had this week as well.
What do you make of the FX impact from the ECB and the Fed policy meetings this week? Fed was pretty standard. Market was expecting 50 basis points of cuts this year ahead of the meeting.
And that's what we got pretty much in terms of where the markets were still more or less priced. So in that sense, it was steady as you go. The statement was a little bit more hawkish, but the communications and the press conference countered that to some degree.
So all in, I don't think any big FX impact. Obviously, we've got the payroll support next Friday. That's the big one.
The inflation data today was reasonable. And the CPI earlier in the month, also reasonable. ECB, definitely a bit more dovish than we thought.
We thought with a two handle on the policy, right, dropping to 275, that there might have been a bit more communication in terms of, you know, we're starting to approach neutral, given the inflation risks, we still need to be a bit more careful maybe. But no, you know, I think definitely more concerned about growth. And interestingly, we're going to have this ECB staff analysis report released on the 7th of February, which will give us an indication of what the ECB's updated thinking is in terms of what the neutral rate is.
So that allowed Lagarde to kind of steer clear of getting into that debate in the press conference. But that analysis on the 7th of Feb will be important in terms of where the markets might adjust to. At the moment, it seems 2% is the consensus for the neutral rate, which is what we would agree with.
Any lower than that, and obviously, it opens up scope for them to be maybe more aggressive to get to that neutral rate. Do you think they're also preempting perhaps tariffs from the US and the impact that may have on growth in the Eurozone? Yeah, yeah.
I think Lagarde didn't want to get too much into that. But obviously, I think in particular for Germany, where, you know, we've had continued disappointing GDP growth and economic activity data, it would be the bigger impact would be there. You know, overall, the Eurozone exports as a percentage of GDP is, it's less than 20%.
So Germany, it's a lot more, but the Eurozone as a whole, it's a lot less. But still, there would be definitely an impact there. And you'd have to debate whether falling inflation, rising real incomes, the potential for increased domestic demand, whether that would offset or not, but certainly it's a downside risk.
I guess jumping across the pond a little bit to next week, we have BOE and the NPC meeting. What are we pricing in for there? And what do we think the sterling impact might be?
Yeah, 25 basis point cut is pretty well priced, newly fully priced. I think NPC voting wise, probably 8-1. Catherine Mann, your guaranteed hawk may well vote against, but you know, Megan Greene possibly could join her, but I think 8-1 is probably more likely.
And yeah, you know, I think they'll be much more confident about the inflation prospects going forward. The CPI data this month was on the services side was a lot weaker than expected, 4.4% down from 5%. And the employment data, if you look at the PAYE, the HRMC data, the tax related employment data is showing the labour market is definitely weakening.
And that will give them more confidence about wages decelerating. Survey data, KPMG, REC survey and jobs data showing a deceleration in wages going forward as well. So yeah, you know, there's about 70 basis points priced.
We think they'll do 100 in terms of cuts. So yeah, I think there's a chance they could show some of that dovishness when they cut next week. So you think that could weigh on sterling?
Yeah, you see, the obvious answer to that is yes. But then of course, you know, sterling has underperformed in January. I think it's still the worst performing G10 currency in January.
And of course, some of that is related to concerns about the fiscal outlook and the gill sell off that we had earlier in the month. And we don't buy that, you know, we just think that the fiscal backdrop isn't, you know, it's problematic and the supply issue is definitely there. But there's plenty of other countries that are in as bad a fiscal situation.
Indeed, the government's projections show a primary budget surplus towards the end of the forecast profile. And they've committed to the self-imposed fiscal rules, which again, could encourage the bank to be a bit more dovish next week. But from a sterling perspective, you could argue that a fall in gilt yields helps reduce that risk and it helps sentiment.
And certainly in that context, I wouldn't argue that it's necessarily as bearish a sterling outcome as you might have thought in usual circumstances. So, you know, we don't have a particularly bearish view for sterling. We think cable will be higher this year.
We've got 130 at the end of the year, even though we've got 100 basis points of cuts for the year. So, and we don't think that rate cuts necessarily will weigh on sterling. Interesting.
And then I guess finally, it'd be remiss of me if I didn't mention the yen, given we're a Japanese bank. Top performing currency in G10 this week, a sign of things to come, do you think? Yes, I do.
You know, the rate hike, while it didn't have particularly notable price action in the immediate aftermath, because it was well telegraphed by the BOJ, it's still an important step. And as I've mentioned before, the kind of short term three month money spread is continuing to narrow, which effectively means the cost of hedging is becoming cheaper for a Japanese investor invested into fixed income in the US. And that, in theory, should gradually result in greater hedging flows, which is yen buying.
And, you know, we saw on Monday, the deep seek turmoil in AI tech. The yen was the top performing currency that day. And with the kind of yield spread beginning to lessen, that means the yen will take on more of that safe haven, traditional safe haven role that it has in the past.
And yeah, you know, I think we still think the Fed are going to cut later in the year and the BOJ could certainly hike, we think, twice more this year. I think means the yen can certainly outperform going forward, like it has done this week, and indeed this month. Okay, well, thank you so much for speaking to me today, Derek, and have a great weekend.