The Canadian dollar remained stable despite a recent increase in tariffs imposed by the US. The USD/CAD rate has reached its 10-week high, indicating the Canadian dollar is at a 10-week low.
US tariffs on Canadian goods have been raised from 25% to 35%. The new tariff rate is set to be implemented in a few hours as US Eastern time shifts to August 1.
Impact on the Canadian Economy
With the new 35% tariff going into effect, we see sustained downward pressure on the Canadian dollar. The move to a 10-week low for the CAD is likely just the beginning of a larger trend. We are positioning for further weakness against the U.S. dollar in the weeks ahead.
This trade action hits an already fragile Canadian economy, where Q2 GDP growth recently slowed to just 0.8% annualized. Conversely, the latest U.S. non-farm payrolls data showed a robust gain of 215,000 jobs, keeping the Federal Reserve on a steady path. This growing economic divergence strongly favors holding U.S. dollars over Canadian dollars.
For derivative traders, the spike in uncertainty is a key opportunity. Implied volatility on USD/CAD one-month options has jumped to over 10%, levels we haven’t seen since the banking stresses in the spring of 2024. Strategies that profit from increased price movement, such as long straddles, should be considered.
Potential Monetary Policy Response
We believe USD/CAD will test higher levels, potentially targeting the 1.4000 psychological mark. We saw a similar pattern during the trade disputes of 2018, where escalating tariff rhetoric caused the pair to rally over 8% in just a few months. History suggests this trend has more room to run.
The market is now aggressively pricing in a response from the Bank of Canada. Overnight index swaps are now implying a greater than 70% chance of a 25-basis-point interest rate cut by the October meeting. This expectation of monetary easing will cap any potential rallies in the Canadian dollar.
