KeyBank FX Market Update – February 3rd

Impact of Newly Implemented U.S. Tariffs on Global Financial Markets

President Trump signed an executive order yesterday enacting significant tariffs, imposing a 25% levy on imports from Canada and Mexico, with a reduced 10% tariff specifically on Canadian energy products. Additionally, the US imposed a 10% tariff on imports from China. The announcement and implementation of these tariffs have led to notable volatility in the foreign exchange (FX) markets.

U.S. Dollar (USD): The U.S. dollar experienced a significant surge, strengthening against a basket of major currencies. This appreciation is attributed to the USD being perceived as a safe-haven status amid escalating global trade uncertainties. The dollar index is trading above 109 early Monday, last hitting this level in December of 2002 (over 22 years ago).

Additional tariff noise is expected over the coming days/weeks, but the overall fundamental backdrop remains unchanged. Robust U.S. growth, elevated inflation, and a more hawkish Fed continues to support higher U.S. yields and a stronger dollar. The tariffs should boost the move.

Canadian Dollar (CAD): The Canadian dollar depreciated against the US dollar, following the tariff announcement. The pair is trading above 1.4600, the weakest level in 22 years. The spread between United States and Canada 10-year bond yields widened 12 bps, led by Canada. This decline reflects investor concerns about the potential negative impact on Canada’s export-driven economy, particularly in sectors such as energy and manufacturing. In a reaction to President Trump’s executive order, Canadian Prime Minister Trudeau announced 25% tariffs on over $100 billion of U.S. goods.

Mexican Peso (MXN): The Mexican peso depreciated over 2% versus the U.S. dollar after the tariff announcement. The pair is currently trading near 21.0000, the highest in three years. Given that a substantial portion of Mexico’s exports are destined for the U.S., the imposed tariffs raise concerns about a potential recession in Mexico if these trade barriers persist. It was reported by Reuters that Mexican President Sheinbaum is considering possible retaliatory tariffs on imports from the U.S., ranging from 5% to 20%.

Chinese Yuan (CNY): The Chinese yuan hit a record low in offshore trading, reflecting market apprehension about the broader economic implications of the tariffs on China’s economy. China indicated “corresponding countermeasures” were to follow in response to the imposed 10% tariff.

Euro (EUR): The European currency also weakened vs the U.S. dollar, trading at 1.0250, the lowest in three weeks. President Trump made it clear that tariffs are coming for the EU, saying he will “definitely” impose tariffs after saying he will “absolutely” do so earlier this weekend. No further details have been announced but he said, “I wouldn’t say there’s a timeline, but it’s going to be pretty soon.” The tariff threat is likely to bolster expectations for easier ECB policy in the months ahead, given the implications for EU growth. Eurozone Manufacturing PMI data for January was revised up (to 46.6, from 46.1) on upwardly revised (but still soft) German data.

British Pound (GBP): The British pound outperformed its G10 peers the U.K. avoided tariffs. The GBPUSD pair is still trading lower near 1.2350, the lowest in two weeks. The U.S. runs a small trade surplus with the UK overall and the UK’s trade advantage lies in services, rather than goods. That does not mean that tariffs in some form are not coming, but the economic hit may be relatively less severe.

Potential Long-Term Effects:

Should these tariffs remain in place, several long-term effects on the global economy and financial markets may materialize:

Inflationary Pressures: The increased cost of imports could lead to higher consumer prices in the U.S., potentially influencing Federal Reserve monetary policy decisions.

Global Trade Dynamics: The tariffs may prompt affected countries to seek alternative trade partnerships, potentially leading to a reconfiguration of global supply chains and trade relationships.

Economic Growth: The heightened trade tensions raise concerns about a potential slowdown in global economic growth, with some analysts warning of recession risks for countries heavily reliant on trade with the U.S.

Conclusion:

The newly implemented U.S. tariffs have introduced significant volatility into global financial markets, particularly impacting the FX markets and resulting in a stronger U.S. dollar. While immediate reactions have been notable, the long-term effects will depend on the duration of these tariffs and the responses from the affected nations. Continuous monitoring of policy developments and market reactions will be essential for informed decision-making in this evolving landscape.

Compliments of KeyBank – a member of the EACCNY