A stronger USD after Trump follows through on tariff threats
USD: Trade war increases downside risks for global growth
The US dollar has strengthened sharply at the start of this week after President Trump followed through on his promises to implement 25% tariffs on both Canada and Mexico as well as raising tariffs by a further 10% on China. It is the first time that a president has invoked national emergency powers (under the Economic Emergency Powers Act or IEEPA) to impose tariffs. The tariffs are scheduled to take effect at 12.01am ET on Tuesday. Trump’s tariffs announcement has already lifted the dollar index back up to within touching distance of the year to date high of 110.18 recorded on 13th January. The Canadian dollar and Mexico peso have understandably been hit the hardest. USD/CAD hit a high overnight at 1.4793 and USD/MXN at 21.293. USD/CNH has hit a fresh year to date high at 7.3734. In contrast, the impact on the US Treasury market has been more modest for now. The two-year US Treasury yield has risen by around 7bps to reflect market participants scaling back expectations for further Fed rate cuts in response to the inflationary impact from higher tariffs on imported goods into the US.
The executive orders to implement higher tariffs send a clear signal that President Trump means business when threatening to implement higher tariffs and represent a significant step up in the trade war started during his first term. In Trump’s first term he placed tariffs on USD380 billion of imports mainly from China. The tariffs proposed this weekend would cover imports totalling USD1.4 trillion focused mainly on Canada, China and Mexico. The other important difference is that this time tariffs will be implemented immediately whereas they were phased in over years during Trump’s first term.
The only concession he made was to apply as smaller 10% tariff on imports of energy from Canada. However, energy imports from Mexico will still be subject to the full 25% tariff. Energy is defined as “crude oil, natural gas, lease condensates, natural gas liquids, refined petroleum products, uranium, coal, biofuels, geothermal heat, the kinetic movement of flowing water and critical minerals. The executive orders also suspend the de minimis exemption on imports from Canada, Mexico and China which allowed imports of USD800 or less (per person per day) to be imported without duties or tariffs. It will particularly hit Chinese e-commerce companies. At the same time, President Trump has warned the EU that tariffs “will definitely happen” and are likely to be ”very substantial”. The actions increase the likelihood that President Trump will implement a universal tariff on all imports into the US of say 10% or 20% as he has previously threatened.
In response Canada has announced plans to retaliate by imposing 25% tariffs on CAD155 billion of imports from the US. They will start by imposing tariffs on CAD30 billion of imports on Tuesday and then expand to another CAD125 billion of imports from the US in 21 days. Canada is also considering non-tariff retaliatory measures related to critical minerals and energy. Mexican President Sheinbaum has stated that Mexico plans to retaliate with tariff and non-tariff measures but has not yet outlined specific details. Finally, China has stated that it will file a dispute with the World Trade Organization and vowed to implement countermeasures against the US but like Mexico has not yet outlined specifics. The retaliatory actions further increase the risk of an escalating trade war that would be more disruptive for global trade and provide a stronger headwind for global growth.
Overall, the tariff announcements from President Trump over the weekend support our forecasts for a stronger US dollar during the first half of this year (click here) which were built on the assumption that he would act quickly to hike tariffs at the start of his second term as president. It was a key reason why we have been forecasting EUR/USD falling below parity, USD/CNY rising up to 7.5000 and USD/MXN moving closer to the 22.000-level. While we had warned that the Canadian dollar and Mexican peso (click here) could decline by a further 5-10% if 25% tariffs were implemented, we did not expect Trump to fully follow through with those threats especially against Canada. We will now have to revise significantly higher our forecasts for USD/CAD when we release our latest monthly FX Outlook report later today to show levels above 1.5000.
So far the initial response for USD/CAD and USD/MXN has been relatively contained considering the scale of the tariff hikes set to be implemented on Tuesday. USD/CAD is currently up by just over 1% and USD/MXN by just over 2%. It could still reflect some outstanding hope that President Trump will back down at the last minute. He is due to hold calls today with Canadian Prime Minister Trudeau as well with the Mexican leadership according to Bloomberg but Trump has downplayed expectations of a resolution. One other option talked about is a possible emergency US court injunction that pauses their implementation. President Trump has set no clear criteria to remove tariffs relating to concerns over fentanyl, immigration and trade. The longer the tariffs are in place the more likely that Canada’s and Mexico’s economies could fall into recession whereas the negative impact would be more modest on the US economy. Exports to the US are worth roughly 20% of Canadian GDP and 30% of Mexican GDP whereas US exports to Canada and Mexico combined are worth only around 3% of GDP.
CAD & MXN SET TO WEAKEN SIGNIFICANTLY TO OFFSET TARIFF HIKES
Source: Bloomberg, Macrobond & MUFG GMR
KEY RELEASES AND EVENTS
|
Country |
GMT |
Indicator/Event |
Period |
Consensus |
Previous |
Mkt Moving |
|
EC |
09:00 |
Manufacturing PMI |
Jan |
46.1 |
45.1 |
!! |
|
UK |
09:30 |
Manufacturing PMI |
Jan |
48.2 |
47.0 |
!!! |
|
US |
10:00 |
OPEC Meeting |
-- |
-- |
-- |
!! |
|
IT |
10:00 |
Italian CPI (YoY) |
Jan |
-- |
1.3% |
! |
|
EC |
10:00 |
CPI (YoY) |
Jan |
2.4% |
2.4% |
!!! |
|
US |
14:00 |
Dallas Fed PCE |
Dec |
-- |
1.80% |
! |
|
US |
15:00 |
Construction Spending (MoM) |
Dec |
0.3% |
0.0% |
!! |
|
US |
15:00 |
ISM Manufacturing PMI |
Jan |
49.3 |
49.2 |
!!! |
|
US |
17:30 |
FOMC Member Bostic Speaks |
-- |
-- |
-- |
!! |
|
US |
18:00 |
Atlanta Fed GDPNow |
Q1 |
2.9% |
2.9% |
!! |
|
US |
19:00 |
Loan Officer Survey |
-- |
-- |
-- |
! |
Source: Bloomberg
