Market Volatility Intensifies Amid Tariff Tensions and Fed Signals

The US dollar has maintained its dominance in the currency markets, emerging as one of the best-performing currencies following a spike in risk aversion after the Trump administration's recent tariff announcements. These tariffs, aimed at Mexican and Canadian exports, have been perceived by many investors as part of President Trump's broader negotiation strategy rather than a definitive shift towards aggressive protectionism. This perception has helped temper the initial market panic, although the underlying tensions remain unresolved.

DXY 1H Chart 

Despite a temporary improvement in sentiment, the USD's continued strength will increasingly rely on the comparative growth and inflation outlook between the US and other G10 economies. The US economy, with its diversified structure and relative independence from global trade, might be better positioned to withstand the pressures of a full-scale trade war compared to its trading partners. However, the high level of international exposure to US equities presents a potential risk. Should the US growth outlook deteriorate, foreign investors might start unwinding their positions in US assets, which could limit further gains for the dollar, particularly against other safe-haven currencies like the Japanese yen (JPY), Swiss franc (CHF), and euro (EUR). Presenting the opportunity to be looking for shorts on USDJPY with the JPY continue to strengths. 

On the economic calendar, speeches by Federal Reserve officials Raphael Bostic and Mary Daly will be closely monitored. Their comments on the potential impact of Trump’s tariff policies on US growth and inflation could influence market expectations regarding future monetary policy moves. If the Fed officials highlight increased stagflation risks—a combination of stagnant growth and rising inflation—this could dampen support for the USD in the near term, but not for long…

While it’s too early to declare the end of the dollar’s reign as the dominant global currency, the sustainability of its current rally will depend heavily on incoming economic data and the broader geopolitical landscape.

CAD: Holding Ground Amidst Tariff Turmoil

The Canadian dollar (CAD) has faced significant pressure following the US administration’s decision to impose tariffs on Canadian imports. This move caused the CAD to slump to its weakest level against the USD in over two decades, with USD/CAD surpassing the peaks recorded in 2016 and 2020. Despite this sharp decline, the CAD’s performance was broadly in line with other G10 commodity currencies and the euro, reflecting a general trend of weakness among currencies tied to global trade and commodities.

USDCAD 15 minutes Chart 

In response to the US tariffs, the Canadian government acted swiftly, imposing 25% tariffs on CAD30 billion worth of US imports and threatening additional tariffs on another CAD125 billion if the situation does not improve within the next three weeks. This tit-for-tat escalation underscores the fragility of the current trade relationship between the US and Canada. However, a temporary 30-day truce was achieved following talks between President Trump and Prime Minister Justin Trudeau, offering a brief respite for markets.

The Bank of Canada (BoC) faces mounting challenges as the prospect of a full-blown trade war looms large. Canadian money markets have already priced in the likelihood of further rate cuts, adding to the BoC’s easing cycle. The BoC has estimated that a comprehensive trade war, with 25% blanket tariffs and equivalent retaliation, could shave nearly 2.5 percentage points off Canada’s GDP in the first year alone. Such an outcome would almost certainly push the Canadian economy into recession this year.

The CAD is likely to remain under pressure in the near term. The currency’s fortunes will depend on the evolution of US-Canada trade relations and the broader trajectory of global trade dynamics.

JPY: A Fortress Amidst Turmoil?

Among the G10 currencies, the Japanese yen (JPY) has demonstrated remarkable resilience amidst the recent market volatility. Despite the fluctuations triggered by President Trump’s tariff impositions and subsequent negotiations, the USD/JPY pair has remained confined within a narrow trading range. This stability reflects the yen’s status as a preferred safe-haven currency during periods of heightened uncertainty.

USDJPY 1H Chart 

Our analysis suggests that the yen’s relative immunity to Trump’s tariff policies, observed during his first term, continues to hold. The yen’s movements have been more influenced by US Federal Reserve rate decisions than by trade-related developments. However, two key factors could alter this dynamic.

First, the yen’s resilience is contingent on the absence of direct US tariffs targeting Japanese exports. While Japan’s trade surplus with the US is significant, it ranks third in the G10 behind Canada and Switzerland. Nevertheless, it remains a potential target. Japan has been proactive in maintaining favourable relations with the US, with notable figures like Masayoshi Son investing in Trump’s Star Gate AI initiative. Furthermore, Japan is the second-largest source of foreign direct investment (FDI) in the US, trailing only Canada.

Prime Minister Shigeru Ishiba’s upcoming meeting with President Trump on February 7 will be closely watched. Ishiba, who leads a fragile minority government, may struggle to replicate the diplomatic rapport that former Prime Minister Shinzo Abe enjoyed with Trump. The outcome of this meeting could have significant implications for the future of US-Japan trade relations and, by extension, the yen’s performance.

Second, the Federal Reserve’s current rate-cutting cycle adds another layer of complexity. Our US economist forecasts an additional 50 basis points of rate cuts this year, slightly more than the 40 basis points currently priced in by the market. Upcoming US labour market and ISM data will be critical in shaping expectations for Fed policy and could influence the yen’s trajectory.

As the week progresses, market participants will continue to monitor developments in global trade negotiations and central bank policy signals, which will play a pivotal role in shaping currency market dynamics.

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