MUFG said the Canadian dollar’s response to new US tariffs on USD 20bn of Canadian exports is likely to depend less on the initial move than on whether the dispute escalates. After negotiations to avert the measures broke down, the currency underperformed its G10 peers, with the risk of retaliatory action described as a key driver of medium-term FX pricing and broader Canadian market conditions. The bank also pointed to fading support from higher oil as an additional headwind if the conflict remains unresolved.
The tariffs, set at 50% on USD 20bn of imports from Canada, took effect at 12:01am on Saturday and cover products including beer, wine, spirits, milk goods and hockey equipment; MUFG said the affected trade represents 5% of Canada’s exports to the US. Looking back to the post-Covid period from 2022, MUFG said USD/CAD has closely tracked the 2-year swap rate spread, and the current 2-year US-CA swap spread implies the pair may be over-extended lower, indicating a level a little above 1.4000, or about 2.0% above Friday’s spot close.
Positioning For Canadian Dollar Weakness
We believe derivative traders should immediately position for a weaker Canadian Dollar by buying USD/CAD call options or entering long forward contracts. With the newly enforced 50% US tariffs on $20 billion of Canadian goods starting this past weekend, the Loonie is highly vulnerable to a downward spiral. Historical precedents, such as the 2018 trade disputes which pushed the Canadian Dollar down by over 5% against the greenback, show how quickly import penalties can erode currency value.
Our analysis of the 2-year US-Canada swap rate spread indicates that the USD/CAD spot rate is currently over-extended to the downside and should be trading above the 1.4000 threshold. This current gap of roughly 2% from last week’s close presents a prime tactical opportunity for options traders looking to capture a rapid upward correction. We recommend targeting short-term expiries over the next two to four weeks to capitalize on this valuation gap before the market fully prices in the friction.
Trading Strategies Amid Retaliation Risks
Because Prime Minister Carney has promised to match any US tariffs “dollar for dollar,” we must prepare for a highly volatile tit-for-tat retaliation cycle. Traders should consider long straddle or strangle options strategies to profit from sharp, sudden swings as retaliatory measures are announced. This volatility play is especially crucial because global crude benchmarks like Brent oil are trading soft at around $76 a barrel, removing the commodity price cushion that normally supports the Canadian Dollar.
