FX markets analyst explains what's driven this volatility and where he thinks the floor for CAD might be
The Canadian dollar has borne the brunt of Donald Trump’s bellicose trade policy. The imposition of US tariffs on Canadian exports has caused foreign exchange markets to rapidly discount CAD against USD, resulting in occasional dips to historic lows. But it’s one thing for tariffs to simply push a currency lower, softening the blow for exporters, it’s another thing for the threat of tariffs to be levied and revoked at apparently random intervals, causing the currency’s value to swing wildly.
Kyle Chapman outlined exactly how the ongoing trade war has played out in FX markets. The FX Markets Analyst at the Ballinger Group explained why CAD has been so volatile and what the long-term impacts of this trade conflict might be for Canadian advisors and their clients.
“It’s been changing by the day. One day there’ll be a tariff threat, the next day it’ll be gone, then a few hours later there’ll be a retaliation,” Chapman says. “The Canadian dollar is significantly weaker now than it was pre-election because this has been priced in as Canada has become Trump’s enemy number one in terms of trade.”
Chapman explained the recent history of CAD against the US dollar that brought us to this point. When Trump initially levelled the threat of 25 per cent tariffs on Canadian goods in February, CAD fell to its lowest point against the USD since 2003. When that threat was delayed, however, markets bought into the idea that this was a negotiating stance and a deal would be struck, resulting in a strengthening of CAD. At the end of that 30-day period, however, the rhetoric was ratcheted up on both sides of the border and a full-blown trade war emerged. That uncertainty has introduced a huge amount of chop into FX markets for CAD, even as the US dollar weakens against other developed markets.
Even if trade uncertainty persists, Chapman acknowledges that there may be less future volatility in CAD, simply because FX markets will become somewhat inoculated against Trump-based noise. Chapman says we’ve already begun to see FX and other markets becoming a bit fatigued. What might have made waves in the first days of his administration is now being shrugged off. While there is still headline risk, we may see volatility come more in fits and starts rather than a sustained trend.
From an investor’s standpoint, Chapman notes that the volatility is harder to manage than persistent weakness. A weak currency, for example, means the currency exposure that comes with US equities holdings is actually a positive. It can also improve margins for exporting businesses. Big swings in the market, however, serve to simply add more chop in an already choppy environment. He notes the value of hedging at times like this to effectively tune out that currency risk.
Looking at the prospects for CAD, Chapman notes that things could still move lower. Under the ‘worst-case scenario’ of sustained blanket tariffs at 25 per cent, he thinks the USD could rise to as much as $1.50 CAD. He sees a push above that point as more of a ‘tail risk,’ but notes that despite what feels like a low point now, “we haven’t seen the most amount of pain we could experience.”
Because the weakness in CAD is so driven by political issues and trade, Chapman believes that a CAD play is hard to find. Going long on CAD right now, he notes, effectively amounts to a bet on what President Trump will do, which seems effectively impossible to know at this juncture.
Rather than focusing on finding an immediate advantage, Chapman extolls the virtue of communication during times like this. Advisors with snowbird clients, in particular, can demonstrate value by explaining the currency issues and the hedges and strategies built into those client portfolios. Without trying to promise the world, too, he notes that there could be some hope found in changes to Trump’s trade policies.
“I think there's a very good chance that things don't get worse. $1.50 is a potential scenario, but it's a tail risk. The Trump administration is moving away from these big tariffs, and they're trying to transition towards a model of reciprocal tariffs, and that should be slightly more benign for the Canadian economy,” Chapman says.
