Global Currencies Are Reshuffling Amid Tariff Threats. Here's Where The Dollar And Other Major Currencies Could Land.

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• Trump announced 25% tariffs on Mexican and Canadian goods, impacting currencies.
• The Canadian dollar, Mexican peso, and Euro could fall further due to reliance on US trade.
• Economists worry tariffs could worsen inflation; Trump blames high energy prices.

Headlines around immigration policies, pardons, and AI investment initiatives have flooded news feeds since Monday. But for markets and central banks, none are more important than further details on tariffs, a sore spot that could hinder inflation, growth, and global currencies.

Jayati Bharadwaj, a global FX strategist at TD Securities, had her phone in hand during Monday's inauguration, awaiting any mention of tariffs so she can cross check the news with movements in the FX market.

As President Donald Trump announced that he would impose a 25% tariff on goods from Mexico and Canada effective February 1, the Canadian dollar and Mexican peso reacted swiftly. The Monday announcement sent the Canadian dollar down 1.5% to as low as 1.45 against the dollar, touching its weakest level in nearly five years, while the peso fell by as much as 1%.

The moves weren't an overreaction, said Bharadwaj, as she awaited further details on whether the tariffs would hit imports across the board or just specific categories. The former would be a bad outcome since the US is the top export partner for both its neighbors. For Canada, over 75% of its exports end up in the US. For Mexico, its key sectors, automobile and agriculture, are reliant on their US trade relationship, making those interlinkages meaningful, she added.

For now, the market's softer reaction stems from two things: the first is an expectation — or even hope — that tariffs would hit a small corner of imports. The second is because previous tariffs from Trump's first term had muted effects. And by 2019, the ones imposed on steel and aluminum from Mexico and Canada were rescinded.

However, if markets were to assume a blanket 25% tariff on, say, Canadian imports, then the CAD would have weakened by at least five times more, Bharadwaj said. It's a sign that we're still in a wait-and-watch mode as more details trickle in from economic advisors who could help paint a better picture of the macro implications.

Going forward, all eyes will be on whether Canadian energy is exempt from tariffs. TD Securities' baseline expectation is that it will be, just because it's a big part of what the two countries trade. Key to this assumption is that Trump's grievance is mainly against trade partners that have a surplus with the US and a cheaper currency.

While Canada does have a surplus, it's mainly due to its energy exports, which are a resource the US needs. If the sector were removed, Canada would have a trade deficit, Bharadwaj noted.

Economists worry that tariffs will aggravate inflation and delay further interest rate cuts. Trump has refuted this claim, instead blaming high energy prices for the soaring cost of goods. During his inauguration speech, he promised to expand domestic energy supply, specifically for oil and gas, to fight inflation. However, substituting imported energy sources would be a timely and costly process.

Canadian tariffs would have the most noticeable cost-of-living impact on the American consumer, said Eric Nuttall, a senior energy portfolio manager at Ninepoint Partners. The US imposing tariffs on its cheapest source of oil, which currently comes from Canada, at a time when US shale is growing at its slowest pace would be a major strain on American energy. If tariffs do go into place, Nuttall believes they will be short-lived.

Currency reshuffles

Either way, the implications for the Canadian dollar aren't looking good. Domestic growth is already moderated, and inflation is almost on target, Bharadwaj noted. In December, Canada's inflation rate came in at 1.83%, which means the Bank of Canada can keep cutting rates for the next four meetings, putting additional downward pressure on the Canadian dollar. TD's forecast for the end of the first quarter is a weakening CAD, climbing to 1.48 against the dollar. It was near 1.44 as of Wednesday.

As for the peso, with a baseline assumption that tariffs won't be across all goods and services, it's expected to move to 21.45 against the dollar. It was near 20.55 on Wednesday.

Outside of North America, if tariffs are imposed on European imports, another major US trade partner, the euro is forecast to reach parity with the dollar. As of Wednesday, it was trading at 1.04.

Meanwhile, Trump has been sounding less severe on China but it's too early to declare that no further tariffs will be seen.

Meanwhile, most investors are already long the dollar and feel the position is overcrowded. Does that mean it should start pushing lower? Bharadwaj's answer is "no".

"We have in-house positioning metrics, and I actually went back in time to look at dollar positioning during the last Trump term. And what's interesting is that investors were able to hold on to the long dollar positioning for an extended period of time," Bharadwaj said, especially during the trade wars of 2018 and 2019.