Market Brief: Renewed Tariff Threats Clobber Currency Markets
The dollar is back on the offensive after Donald Trump last night said he favours implementing universal tariffs “much bigger” than 2.5 percent. Speaking to reporters aboard Air Force One, the president appeared to double down on threats against auto manufacturers in Canada and Mexico, and said the US would soon hit pharmaceuticals, chips, semiconductors, steel, copper, and a range of other categories with import taxes.
An earlier report from the Financial Times suggested that newly-confirmed US Treasury Secretary Scott Bessent supports applying an initial 2.5-percent tariff against all US trading partners, with an increase in the same amount coming each month until trade negotiations are concluded. The duties would climb as high as 20 percent within eight months, giving countries a chance to negotiate with the Trump administration.
The greenback has almost fully unwound last week’s losses, and most majors—including the euro, pound, yen, and Aussie—are sitting on losses amounting to roughly half a percent relative to last night’s close. After a turbulent session yesterday, the Canadian dollar is down about a quarter percentage point against the dollar.
Administration officials believe that universal tariffs would help counter efforts to reroute Chinese manufactured goods through third-party countries. As most trade experts* predicted at the time, the share of US imports coming from countries with strong geographical ties to China—like Vietnam, Taiwan, South Korea, and India—did increase dramatically in the years during and since Trump’s last turn in office, suggesting that transshipment flows are significant. But Bessent’s plan to announce a graduated across-the-board tariff schedule in advance might have profound implications for inflation expectations—consumers would surely interpret this to mean that goods prices were on an upward-sloping path, and businesses would seize the opportunity to increase prices accordingly—while also levelling the playing field in China’s favour, all else being equal.

The dust is settling in stock markets after yesterday’s selloff in artificial intelligence-related companies wiped out more than hundreds of billions in paper wealth. The drop in Nvidia’s share price amounted to history’s biggest one-day single-stock loss, but left the company with a $2.9-trillion dollar capitalisation, placing it just behind national equity market valuations in Canada, France, and the United Kingdom. The ‘Magnificent Seven’ group of technology companies to which it belongs are worth more than all of Europe’s public equities combined, and almost twice as much—on paper—as China’s stock markets. For many global investors, there’s simply no viable alternative to investing in US markets.

The Canadian dollar remains on the backfoot as Saturday’s tariff deadline looms, and demand for hedges against downside risk in the currency has reached heights not seen since the beginning of the Federal Reserve’s tightening cycle. It’s still not our base case, but we think the currency could tumble through the 1.50 threshold against the greenback in short order if the US follows through with implementing 25-percent tariffs on imports from Canada.

To expound further on a theme we touched on yesterday**, it seems that an increase in Canadian defence spending offers the greatest potential for alleviating tensions with the new administration. The chart below, which depicts the gulf in defence expenditures between the US and its allies, illustrates the extent to which American money fundamentally underwrites the global security architecture that protects and enables international trade.

Canada has failed to meet its NATO spending commitments for decades, despite having the economic capacity to do so. The country currently spends less as a share of gross domestic product than any other member—save tiny Belgium and Luxembourg—even as its relatively-strong fiscal position gives it the firepower to contribute far more.

An agreement with the US to increase military expenditures could bolster Canada’s role in global alliances, support domestic defence industries, increase productivity***, and help mitigate the threat of tariffs. A "deal" could be politically galling for many Canadians, and might not last longer than Trump’s attention span****, but would offer the Canadian economy—and the loonie—some respite at a time when relief is sorely needed.
*And anyone with an understanding of history.
**Please forgive the editorialising here.
***An extensive body of research suggests that, on balance, defence expenditures subtract from long-term gross domestic product growth. But if funds were devoted to areas that generate innovative spin-offs, the effort could prove more supportive than economic theory would suggest.
****Note that the recent tariff threats come after Trump signed the United States-Mexico-Canada Agreement in 2020, calling it a "terrific" deal for America.
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