CAD Plunges Following Trump’s Tariff Threat
President-elect Donald Trump has announced plans to impose a 25% tariff on all US imports from Canada and Mexico, along with an additional 10% levy targeted at China. These announcements, signalling the start of Trump’s combative trade agenda, have unsettled FX markets. The Canadian dollar (CAD) weakened by as much as 1.5% within two hours of the remarks, offering a glimpse of the volatility that could define a second Trump presidency.
The initial reaction in the dollar-yuan pairing has been muted; however, the Mexican peso mirrored CAD’s performance, shedding 1.5% so far today. USD/CAD has surged to its highest level in over four years, and the escalation of tariff tensions suggests further gains towards C$1.45 are plausible. Both the pound and euro are benefiting from the weaker Canadian dollar, rising about 0.7% this morning, with GBP finding solid support at its 200-day moving average.
While the full scope of potential retaliatory measures from affected countries remains uncertain, the likelihood of fresh headlines keeps volatility risks elevated. Today’s market reaction to Trump’s comments, combined with the experience of his first term, indicates FX traders are bracing for a turbulent four years. Although options markets trimmed bets on a stronger US dollar following the announcement of Scott Bessent as Treasury Secretary, the tariff headlines have reignited dollar strength across the board.
A Temporary Boost for the Euro
Europe’s economic struggles were underscored this week by Germany’s Ifo index, a key leading indicator, which saw another decline. Despite this, EUR/USD managed a modest recovery from Friday’s dip to $1.0335, hovering just below $1.05. However, concerns over stagflation in Europe suggest that further declines in EUR/USD are likely as the year progresses, even as seasonal trends typically offer support.
After showing a brief recovery in October, the Ifo index fell again in November, declining to 85.7 from 86.5. The drop was driven more by current conditions than future expectations, with weak industrial orders and negative headlines surrounding the war in Ukraine weighing on sentiment. With no substantial tailwinds in sight, parity between the euro and the dollar appears increasingly probable within the next year. Bloomberg data now places the options-implied probability of parity trading within the next six months at 30%, up from 20% at the start of November.
Net short positions in the euro against the dollar have increased, according to COT data, but remain below levels seen during past crises, suggesting room for further downside risks. If Europe’s economic challenges persist, the euro could face its worst two-month stretch since January 2015.
The Pound Struggles for Momentum
GBP/USD is finding it difficult to reclaim the $1.26 level and its 100-week moving average, despite the US dollar beginning the week on a softer note. The yield spread between the UK and US remains relatively stable, with falling yields in both markets. However, the pound has failed to capitalise on improving global sentiment, as evidenced by Monday’s rally in global equities.
The pound also slipped below €1.20 against the euro, losing approximately 0.5% on Monday—its worst single-day performance this month. Money markets are pricing less than a 20% chance of a Bank of England (BoE) rate cut in December, with three cuts fully expected by the end of 2025. While recent inflation increases and fiscal expansion suggest a slower pace of BoE rate cuts initially, rising stagflation concerns are limiting sterling’s potential gains from this outlook.
Looking ahead, the UK’s trade deficit in goods with the US likely reduces its direct exposure to Trump’s proposed tariffs. This supports the case for UK economic outperformance relative to the Eurozone, potentially keeping GBP/EUR on an upward trajectory.
Against the US dollar, however, the picture remains less optimistic. Even with weak seasonal trends for the dollar and month-end flows favouring USD selling this week, GBP/USD remains in a downtrend as long as it trades below $1.28 and its key 200-day and 200-week moving averages, which are clustered around this level.
