A 50% tariff breaks the logic of the Canadian dollar rebound! USD/CAD approaches 1.40 as bears regroup

According to Zhitong Finance APP, the collapse of US-Canada trade negotiations and the imposition of a 50% tariff by the United States on Canadian goods worth tens of billions of dollars are jointly and sharply depressing the Canadian dollar in the short term through three channels: “downward revision of growth expectations, cooling expectations of Canadian rate hikes, and rebuilding of short positions.” If Canada implements “equivalent retaliation,” it could further weaken business confidence and the momentum of economic recovery.

Short-term risks for the Canadian dollar remain tilted to the downside. USD/CAD may test 1.40 and even depreciate to 1.41 in the third quarter. However, if US rate hike expectations also ease simultaneously, it may limit the pair’s sustained significant break above 1.40, meaning trading opportunities are closer to repricing within a high-volatility range rather than a clear one-way USD trend.

After the trade talks between Canada and the United States broke down, the Canadian dollar is heading for its worst trading day against the US dollar in more than two months. The latest statistics show that the Canadian dollar once fell 0.6% to 1.3844 per US dollar, ranking first in declines among all G10 currencies and potentially marking its worst performance since June 17. Market observers point out that the sell-off may continue to expand, as Washington's latest 50% tariffs on Canadian goods worth tens of billions of dollars threaten the ongoing economic recovery originally expected in the coming months.

As shown in the chart above, the breakdown in trade talks has curbed the appreciation of the Canadian dollar. Before the latest round of selling, the Canadian dollar had risen by a cumulative 3.5%.

Derek Halpenny, Head of Global Markets Research for EMEA at Mitsubishi UFJ Financial Group, said that Canadian Prime Minister Mark Carney's pledge to impose “equivalent retaliation” on US tariffs has further undermined investor confidence. Mitsubishi UFJ Financial Group expects the Canadian dollar to fall to 1.41 per US dollar in the third quarter. Halpenny noted: “The longer this escalating trade war remains unresolved, the greater the downside risks become.”

This marks a sharp reversal in the Canadian dollar’s trend, after persistent gains since late June. According to data from the US Commodity Futures Trading Commission, the current positioning in the Canadian dollar suggests there is still room for the latest selling wave to expand. In late July, bearish bets on the Canadian dollar reached a two-year high. Over the past month, hedge funds have continuously reduced their short positions on the Canadian dollar, leaving room for these bearish bets to be rebuilt.

Elias Haddad, Global Market Strategy Director at Brown Brothers Harriman, noted that the swap market is currently pricing in about 70 basis points of cumulative rate hikes by Canada through June. Should these expectations subside, the Canadian dollar will continue to come under short-term pressure.

Haddad pointed out that the escalating trade war is likely to dampen market expectations for Canadian rate hikes in the coming months. However, at the same time, there is also a risk that US rate hike expectations may cool. Combined with possible measures by the US Treasury to further depress long-term US Treasury yields, these trends “should collectively limit USD/CAD from excessive surges above 1.4000.”

It is understood that after three days of intensive negotiations and a brief postponement of tariffs by the US, negotiations collapsed on August 21 with no new round scheduled. The US accuses Canada of refusing to implement previously agreed terms and continues to demand additional concessions in steel, aluminum, automotive, and softwood sectors. Canada, in turn, accuses the US side of adding “uneconomic and unfair” conditions, including restrictions on Canada's ability to reach trade agreements with third countries, and undermining the competitiveness of its manufacturing industry on issues such as medium- and heavy-duty trucks.

The US has now invoked Section 338 of the Tariff Act of 1930 to impose a 50% tariff on nearly $20 billion worth of Canadian goods, including wine, dairy products, cement, furniture, clothing, and ice hockey equipment—covering roughly 5% of Canada's exports to the US—and will no longer grant exemptions under the US-Mexico-Canada Agreement (USMCA). This means, outside of these nearly $20 billion in goods explicitly covered by Section 338, other Canadian products that meet rules of origin will, in principle, still enjoy USMCA benefits; but goods in steel, aluminum, automobiles, and softwood, which are subject to other special tariffs, are not necessarily exempted.

Canada has suspended negotiations and announced that from September 8 it will impose "equivalent retaliation" on US goods, targeting steel, dairy, home appliances, agricultural equipment, pulp and paper, and electronic products. Canada is also prepared to provide potentially multi-year assistance to affected industries. From an asset pricing perspective, the $20 billion scale is not enough to cause a severe blow to overall North American trade, but will create highly concentrated growth shocks for Canada's automotive, timber, alcohol, and small- and medium-sized exporters. This will suppress Canadian rate hike expectations and widen the risk premium on the Canadian dollar; the US, in turn, will face rising costs for some manufacturing inputs and consumer goods. The real systemic risk lies in the fact that both sides have shifted from “exchange of tariff reliefs” to “retaliation to force the other’s concession,” which not only raises the cost of the entire North American supply chain but also increases the policy discount for future USMCA renewal and investment decisions.