Canadian Dollar Braces for Volatility as Trump Takes Office

As President-elect Donald Trump assumes office, the Canadian dollar (CAD) is poised for a tumultuous week amidst concerns over potential US tariffs on Canadian exports.

Rising Volatility

The CAD surged 1.2% on Monday, its strongest performance since May 2023, driven by reports that the Trump administration may delay implementing new trade measures. However, earlier in the day, the currency had plummeted to its lowest level since the pandemic.

The options market reflects expectations of further CAD losses, with traders hedging against short-term fluctuations at the highest cost in eight years. "The market is panicking," said Wells Fargo strategist Erik Nelson.

Trump's Impact

Trump has threatened to impose 25% tariffs on all Canadian goods, sparking fears of a trade war and speculation about Canada joining the US. This has heightened volatility and made hedging against CAD swings increasingly expensive.

Outgoing Prime Minister Justin Trudeau has threatened counter-tariffs, further escalating tensions. Analysts predict tariffs on Canada, Mexico, and China could be announced soon.

Trading Levels and Outlook

As of 9:15 a.m. New York time, CAD traded around C$1.4315 per US dollar, after hitting a near five-year low of C$1.4486. It is currently poised for a rollercoaster week, with risks skewed to the downside.

Monex Europe projects CAD could reach C$1.50 before mid-year, while Rabobank anticipates it may fall to C$1.48, both of which would be multi-decade lows.

Options Market Sentiment

Despite the CAD's recent decline, some traders believe it may not yet fully reflect the potential impact of tariffs. Options pricing indicates positioning for further losses, with risk reversals suggesting bearish sentiment not seen since March 2020.

Potential Scenarios

If Trump implements tariffs as threatened, the CAD could "explode through recent range highs," warns Brad Bechtel of Jefferies. However, if he delays or adopts a more gradual approach, volatility could subside.

Rabobank believes Trump is unlikely to impose the full 25% tariff threat, as it would increase energy prices for US consumers. "Anything short of an immediately-imposed 25% US tariff on Canadian goods should result in USD/CAD vol coming back to Earth quite quickly," concludes Wells Fargo's Nelson.