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Summary
- Since the US election on 5 November, USD/CAD has rallied about 4.75%, and closed 2024 at the highest level since Q1 2003 (quarterly).
- President Donald Trump’s threatened 25% tariffs on Canada, with tomorrow (1 February) as a likely imposition date, has partly driven CAD weakness.
- However, the tariffs might not include oil, which should reduce downward pressure on the Canadian dollar.
Market Implications
- We like scaling into a USD/CAD short. The tariff threat will drag on beyond tomorrow, even if oil is excepted from tariffs in the near-term. Nonetheless, a cautious approach to selling USD/CAD is favoured.
USD/CAD Has Been on a Tear in Recent Months
Like the broader US dollar index (DXY, covered last week) USD/CAD has risen strongly throughout Q4 and into this month.
USD/CAD rose about 4.75% since Trump’s election, and about 7% since the end of Q3 (Chart 1).
Quarterly, USD/CAD closed 2024 at the highest level since Q1 2003 and has advanced further this month (Chart 2).
Bank of Canada Has Quantified Tariff Impact on USD/CAD
This week, the Bank of Canada (BoC) said ‘most of the [CAD] depreciation is explained by the foreign exchange rate risk premium,’ which uncertainty over tariffs is largely driving.
When asked to quantify the tariff impact on CAD, the BoC said 4-5% of the recent 7% decline in CAD is due to tariff threats.
Long USD/CAD Positioning Is Stretched
This week’s Momentum report shows the extent momentum players remain long USD across-the-board (Chart 3).
GBP/USD and USD/CAD are USD longs standouts.
Long USD/CAD has been one of the more popular USD longs in recent months and, even as momentum players have trimmed back USD longs recently (notably versus EUR), USD/CAD has not seen any paring of exposures.
Also, the most recent CFTC data shows hedge funds (HF) and real money (RM) are very short CAD (Charts 4 and 5).
With momentum players, HF and RM very short CAD, we think bullish USD positioning in USD/CAD is crowded.
Lutnick Comments Are (Maybe) the Near-Term Tell
Trump’s Commerce Department nominee, Howard Lutnick, testified before the Senate Commerce, Science, and Transportation Committee on Wednesday. Lutnick addressed tariffs against Canada and Mexico, outlining key criteria for America’s neighbours to avoid these tariffs.
‘It is not a tariff, per se,’ said Lutnick. He added ‘It is an action of domestic policy. Shut your border and stop allowing Fentanyl into this country, killing our people. So, this is a separate tariff to create action from Mexico and action from Canada, and as far as I know they are acting swiftly, and if they execute it there will be no tariff.’
This is one of the clearest outlines of what the Trump administration wants and, as such, provides a clear game plan for Canada to avoid tariffs.
Although, Trump is a mercurial character, and anything can happen, sometimes at very short notice.
Nonetheless, Lutnick’s comments help Canada know how it can minimise potential tariffs.
Canada Has Already Acted on US Priorities
Canada, after talks with the Trump administration, has already taken concrete steps to address border issues.
This month, the Government of Canada outlined how it has already ramped up border security, announcing a CAD1.3b investment for more personnel, new technology and equipment, and enhanced coordination.
Canada’s Foreign Affairs Minister, Mélanie Joly, met her US counterpart Marco Rubio this week, saying the meeting was positive and Rubio was receptive to her arguments that tariffs would harm both countries and that Canada is addressing concerns about border security and fentanyl trafficking.
Oil Might be Excluded From Tariffs
There is speculation that oil may be excluded from tariffs, with Trump saying he will be ‘making a determination on oil’ when speaking about tariffs yesterday.
Excluding oil from tariffs would reduce the impact of tariffs on the Canadian economy.
As a result, with so much ‘tariff premium’ priced into the USD/CAD exchange rate, an oil exception should see ‘buy-the-rumour, sell-the-fact’ price action, causing USD/CAD downside.
Tariffs Will Remain an Issue
Even if the near-term tariffs exclude oil, the looming threat of additional tariffs in April persists, after a broad review of trade policy by the Trump administration.
Lutnick also referred to this in his testimony.
Nevertheless, given crowded long USD/CAD positioning, and the potential tariffs being less extensive than initially feared, we think now is time to slowly fade recent USD/CAD strength.