Trump’s message – more tariffs are still coming

USD: Trump signals China tariff action

We stated here yesterday that although there was less action on tariffs in day one announcements it was still highly likely that there would be considerable tariff action going forward as Trump sticks to his pre-election commitments. Within 24hrs of announcing plans to implement a 25% tariff on Canada and Mexico imports Trump confirmed his plan to implement a 10% tariff on all China imports. Like with Canada and Mexico, 1st February was cited as a start date for the action.

Trump did announce an investigation into whether China had kept to the terms of the Phase One trade deal signed during Trump’s first term in office but that process will take time. The 10% tariff mentioned yesterday would be in response to China’s role in fentanyl coming into the US from China via Canada and Mexico. For a tariff to be adopted so quickly no investigation process would take place and the Trump administration would likely use the International Economic Emergency Powers Act. The US dollar weakened ahead of this announcement by Trump and has only strengthened modestly in response. USD/CNY jumped and CNY is the clear underperformer in Asia FX today. The CSI 300 is down 1.0% and the Hang Seng is down close to 2.0%. The rest of Asian equity markets were helped by tech related stocks fuelled by the unveiling by Trump of an AI joint venture initiative that will see USD 100bn of initial investment led by Softbank, OpenAI and Oracle Corp. The positive risk appetite in equities is another factor curtailing the rebound of the US dollar.

Furthermore, while the China tariff announcement does point to the prospect of wider tariff action we would still argue that the US dollar at recent highs was consistent with a high expectations of widespread tariff action. A 10% tariff on China is less than the 60% level that had been mentioned. Of course, the investigations announced yesterday that will report by 1^st April likely will result in further China tariff actions, but there is still a degree of greater caution than many had anticipated prior to inauguration. In addition, as stated below, the reactions of CAD and MXN does also indicate to us a degree of hope that negotiations will result in less action being taken than a widespread 25% tariff across all US imports from Canada and Mexico. Trump yesterday also threated the EU with tariffs based on the size of the US trade deficit with the EU.

So we remain of the view that while the dollar has weakened on a more pragmatic approach so far taken by Trump on trade tariffs, renewed appreciation is still most likely. The Trump administration based on announcements already still looks likely to actively use trade tariffs as a key economic policy tool. The long dollar position is a crowded trade which has encouraged some modest liquidation of positions but the fundamentals to argue for a dollar sell-off at this stage are not there.

CNY REBOUND YESTERDAY IS REVERSING AND DOWNSIDE RISKS REMAIN WITH TARIFFS COMING

Source: Bloomberg, Macrobond & MUFG GMR

CAD: Muted sell-off points to hope through negotiations

USD/CAD hit a new intra-day high yesterday of 1.4516 – the first breach of the 14500-level since March 2020 when the global pandemic was having its biggest impact on risk appetite in the financial markets. But USD/CAD then retraced that move and ended the day close to unchanged. The recovery in USD/CAD certainly suggests to us that investors are optimistic that President Trump will not follow through with a 25% tariff on all imports from Canada. Trump suggested 1^st February as the possible date although he didn’t seem 100% committed to that date but if so leaves about 9 days for negotiations to take place to either cancel the threat of dilute the tariff rate or agree carve-outs for certain sectors (crude oil and autos for starters?). Given the impact a 25% tariff would have from combined Canada/Mexico imports on the US economy there is certainly a logic to investors believing this threat will be changed in some way prior to implementation. Trump did threaten Mexico with increased tariffs in his first term in office but an agreement was reached to avoid the tariff.

The good news for Canada is that inflation is notably lower than in the US that could mean there is a bigger incentive in Canada to retaliate which could too prompt a rethink from the Trump administration. Inflation data was released yesterday and headline annual rate was a touch softer than expected at 1.8% in December. The December data confirmed that annual inflation in Canada has been at the 2.0% target or below for five consecutive months underlining the prospect of the BoC having achieved its goal. Still, the data was flattered by a one-off tax holiday impacting prices while there are some signs of a pick-up in underlying inflation on a 3mth basis. Still, Canada’s inflation backdrop looks more favourable than in the US and if Canada did retaliate the BoC is in a relatively position than the Fed to lower rates to help support the domestic economy to offset the inevitable hit to external demand from US import tariffs.

Retaliation seems likely with PM Trudeau stating that he supports a plan to retaliate “dollar-for-dollar” but we will have to gauge developments over the coming days. If there’s no sign of negotiations or progress in negotiations and Trump keeps repeating his plans, we will see USD/CAD and USD/MXN jump notably higher. Our USD/CAD forecasts for Q1 and Q2 (1.4500 & 1.4400) did not incorporate a broad-based 25% tariff. The 2020 high (1.4668) and the 2016 high (1.4690) would likely be taken out quickly and a move into a 1.5000-1.6000 range (last seen in 2003) would come into play.

USD/CAD HEADING BACK TOWARD RECORD HIGHS  

Source: Macrobond

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:30	ECB's Knot speaks				!!
US	12:00	MBA Mortgage Applications (WoW)	--	--	33.3%	!
CA	13:30	IPPI (YoY)	Dec	--	2.2%	!
CA	13:30	IPPI (MoM)	Dec	0.8%	0.6%	!
CA	13:30	RMPI (YoY)	Dec	--	2.0%	!
CA	13:30	RMPI (MoM)	Dec	0.4%	-0.5%	!!
US	15:00	US Leading Index (MoM)	Dec	-0.1%	0.3%	!
EC	15:15	ECB President Lagarde Speaks	--	--	--	!!!
US	18:00	20-Year Bond Auction	--	--	4.686%	!!
GE	18:30	ECB's Nagel Speaks	--	--	--	!!

Source: Bloomberg