As Trump escalates threats of imposing an additional 25% tariff on Canada starting February 1st, the CAD has weakened, leaving room for USD/CAD to move higher and continue its upward trend in the coming months. Additionally, Trump's renewed tariff threats against the EU and China have introduced another layer of uncertainty for these currencies, further bolstering USD strength in the near term.

USD: Trump 2.0

The USD remains well-supported due to strong economic fundamentals, cautious Federal Reserve commentary on rate cuts, and anticipation surrounding Trump's inauguration. Markets are keenly focused on Trump’s clarity on key policies, including tariffs, tax cuts, and immigration reforms, all of which could significantly influence economic growth and inflation. While there were recent reports suggesting Trump aides considered universal import duties, Trump quickly denied them. Early discussions around tariffs indicate a potential gradual hike of 2–5% monthly, but no final decision has been approved. If Trump’s actual tariff policies fall short of market expectations, a significant USD sell-off may occur, as much of the USD’s strength is already reflected in its price.

Aside from political, December's CPI release has reinforced the Fed's gradual rate cut strategy, aligning with its commentary on easing inflation concerns. Softer inflation data eased fears of persistent price pressures, as core inflation slowed for the second consecutive month. This trend supports the Fed's plans for two additional rate cuts this year, with markets anticipating the next move in Q2. December's core inflation rose 0.23%, driven by modest gains in core goods (+0.05%) and services (+0.27%), while the Fed's preferred core services ex-housing measure was subdued at +0.21%. These figures, alongside a softer PPI report, suggest the core PCE deflator rose by only 0.19% m/m. Although lower yields briefly softened the USD, the currency's bullish momentum remains intact. Sustained employment growth and initial policy directions under Trump could delay early rate cuts, but current data highlights a slowing inflation trend that supports the Fed's cautious approach. It will likely take more than a single month of softer inflation to shift the market’s strong sentiment toward the USD.

Looking ahead, the market focus will shift to Trump's inauguration and US preliminary PMI data. Any disappointment in Trump's policies, particularly tariffs, could trigger a USD sell-off and renew expectations for an earlier Fed rate cut. Overall, while current USD strength reflects optimism, it remains vulnerable to political developments and economic data surprises.

CAD: Tariffs Threat

This week saw limited developments in the Canadian dollar, but the outlook remains clouded by ongoing external and domestic factors. Market attention continues to focus on the upcoming Trump inauguration, where the potential confirmation of tariff policies could significantly pressure the CAD further. On the domestic front, Prime Minister Trudeau’s resignation has delayed the possibility of a Canadian general election until late Q2 or summer, with Parliament suspended until March 24. This maneuver avoided a confidence vote, providing the Liberal Party time to select a new leader. Potential candidates include Chrystia Freeland and Mark Carney. While the USD/CAD initially moved lower on the news, reflecting reduced near-term election risk, medium-term risks remain tilted toward CAD weakness. These include concerns about tariffs and policy divergence, particularly given the new U.S. administration's trade-centric rhetoric. As a result, Goldman Sachs’s USD/CAD forecasts have been adjusted higher, targeting 1.46 over the next 3, 6, and 12 months.

Looking ahead, the market’s focus will not only remain on Trump’s inauguration but also on Canada’s December CPI data. The Bank of Canada (BoC) has previously stated that if inflation continues to align with their forecast and expectations, they may proceed with another rate cut. Consequently, if inflation prints lower or indicates further cooling, it will add another layer of pressure on the CAD, especially if U.S. tariff policies are confirmed. Currently, market pricing in a 70% chance of a January rate cut by the BoC. In summary, the interplay between domestic inflationary trends and external trade risks will be pivotal in shaping the CAD’s trajectory.

Current market context

On the second day of Trump's second term, a Wall Street Journal article suggested that no immediate tariffs would be imposed on Canada. However, overnight, Trump was quoted saying, "We are considering a 25% tariff on Canada, and I think we will implement it on February 1st," which led to a decline in the CAD.

During the early Asian session today, Trump further commented on his tariff plans, stating that a 10% tariff on China would take effect on February 1st. He also escalated threats toward the European Union. These developments indicate that tariffs will be introduced gradually, providing further support to the USD in the near term.

USD/CAD 4H Chart

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