Market Brief: Trade optimism boosts major currencies against the dollar

Global financial markets are starting the week on a buoyant note, with risk-sensitive assets climbing amid hopes of a more lasting thaw in US-China trade relations. The dollar is retreating, benchmark Treasury yields are pushing lower, and equity futures are rising after negotiators on both sides said they had made significant progress on issues including tariffs, fees, and export controls in the weekend’s bilateral discussions in Kuala Lumpur. Treasury Secretary Scott Bessent noted that a “very successful framework” had been established ahead of this week’s meeting between President Trump and Xi Jinping.

The Canadian dollar is—somewhat counter-intuitively—pushing higher even after President Donald Trump threatened to impose an additional 10 percent tariff on imports from Canada. In a social media broadside on Saturday evening, Trump responded to an ad campaign that he said misrepresented comments by former President Ronald Reagan, saying “Because of their serious misrepresentation of the facts, and hostile act, I am increasing the Tariff on Canada by 10% over and above what they are paying now”. The ad, funded by the Ontario government, is composed of excerpts from a 1987 radio address in which Reagan argued that tariffs hurt competition, raise prices, and contribute to job losses*.

Traders are convinced that the Trump-Always-Chickens-Out playbook remains in force, and see the post as yet another in a long line of threats that will ultimately end with tariff rates only marginally higher than before. Implied volatility in dollar-Canada currency options is moving upward, but still looks mostly elevated around November 5, when the Supreme Court is scheduled to hear arguments in a case challenging the president’s use of the 1977 International Emergency Economic Powers Act to pass his tariffs. After losses in three lower-level cases, many legal scholars think the country’s highest court will agree that the tariffs exceeded presidential authority, meaning that the government would no longer have authority to collect duties, and may be required to refund monies already taken in. This wouldn’t nullify the administration’s tariff push—a number of sector-specific levies could remain intact—but would significantly reduce the burden on US importers and export-sensitive economies like Canada’s.

The week ahead could prove unusually turbulent. With the US government shutdown entering its fourth week, most official data releases will remain on ice, but markets will hardly be starved of catalysts. Four major central banks are due to announce policy decisions, US-China trade negotiations threaten to unleash another volley of headlines, and five of the “Magnificent Seven” technology giants—Amazon, Apple, Alphabet, Meta, and Microsoft—are set to report their latest earnings against an increasingly-fragile investment backdrop.

Markets now see a Bank of Canada rate cut on Wednesday as all but certain, with swap-implied odds hovering near the 90 percent mark. Policymakers are expected to look past the recent, modest uptick in inflation and focus instead on countering mounting economic slack and offsetting the extraordinary levels of trade-policy uncertainty clouding the outlook for businesses and consumers. We share that view (and have for several months), but see the Canadian dollar’s risk profile as increasingly asymmetric: with “sell the rumour, buy the news” dynamics in play, the loonie may have limited downside if the Bank meets expectations—and could even rebound if Governor Macklem frames the move as a “hawkish cut,” signalling that rates are approaching neutral.

Signs of a softening in services price pressures in Friday's inflation report left the Federal Reserve on course to cut interest rates at this week’s meeting. The headline increase in consumer prices edged closer to the top of the central bank’s target range in September as both the core goods and food categories pushed higher, but shelter costs dropped by more than had been expected, weighing on an inflation basket that is heavily weighted toward intangible goods. Chair Jerome Powell will almost certainly depict the move as a precautionary step taken to address potential downside risks in employment markets, while maintaining the data-dependent stance adopted in recent months. Perhaps more importantly, the central bank seems likely to announce an end to its circa-$2.2-trillion quantitative tightening effort, given that commercial bank reserves have now reached a theoretical equilibrium between “abundant” and “scarce”. Investors should interpret this as risk-positive, given that it might help offset a recent, modest tightening in financial conditions.

The European Central Bank is seen leaving rates unchanged on Thursday, and should keep its guidance largely intact, leaving currency markets without a domestically-led catalyst for volatility. Euro-area core inflation is sitting near 2.4 percent—well within the Bank’s target zone, expectations remain well anchored, and policy settings are widely believed to be near neutral. The Bank of Japan will also likely stand pat, with weak underlying inflation and only tentative guidance toward policy change.

Broadly speaking, the greenback should trade with a weakening bias this week, but with "dollar smile" dynamics back in place, we would caution that any unexpected shock—related to a turning in the artificial intelligence-led speculative cycle, from a breakdown in trade negotiations, or something else—could see this reverse violently.

*Reagan was, of course, deeply opposed to tariffs, and remained committed to free trade throughout his presidency, repeatedly vetoing Democrat-led protectionist efforts resembling those now enacted under a Republican aegis. Time is a flat circle : )

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