Trade Battle
Leading up to last week, there had been a binary risk event priced into the Canadian Dollar. That event regarded US-Canadian tariffs and specifically, whether an agreement could be reached during negotiations to prevent tariffs being imposed by the United States on imports of Canadian goods. The initial deadline was extended by POTUS creating optimism locally that excessive tariffs would not be imposed on this significant cross-border trade flow. However, that initial optimism now appears severely mis-placed with a breakdown of trade negotiations on Friday leading to the imposition of unilateral tariffs by the United States on Canadian goods.
In retaliation, Canadian Prime Minister Mark Carney announced retaliatory tariffs against the United States. Those “dollar-for-dollar” tariffs will hit around $20bn worth of trade and come into effect from September 8th. The market’s reaction was, as expected, to price in additional risk and economic downturn within the Canadian economy. Any reciprocal move within the US Dollar was imperceptible due to the dominance of the US Dollar in the FX market making it accountable to greater forces than a specific cross-border trade. USDCAD traded with a circa 0.5% premium versus Friday’s close, absorbing a significant bid into Canadian short-term debt.
Implied volatility leading into the late-negotiation phase had been on the rise. A couple of weeks ago 1-month implied volatility stood nearly 1% lower than it does today, closing at 4.77% yesterday. Despite the bad news of a negotiation breakdown representing a reduction in uncertainty, the risk to trade brought about by the imposition of tariffs has resulted in elevated perceived risk throughout longer-dated expiries. This signals a prolonged period of uncertainty surrounding the Canadian economy. What every Canadian exporter will be asking now is: will we see a TACO trade or a painful new longer-term economic reality for Canada? So far at least, the incumbent logic is not to expect a change in negotiating positions from POTUS until after the US mid-terms in early November at the soonest.
Discussion and Analysis by Charles Porter
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