Market Brief: Potential Dilution in Trump Tariff Plans Pummels Dollar

As the curtain rises on 2025, the dollar is tumbling on a report suggesting that incoming US president Donald Trump will ultimately implement tariffs on a much narrower set of products than he had threatened on the campaign trail. According to the Washington Post, advisors to the president-elect are preparing plans to impose import taxes on goods deemed critical to national or economic security—products related to defence industries, strategically-important energy inputs and commodities, and critical medical supplies—instead of the “universal” 10-to-20-percent tariffs previously proposed. This would inflict less pain on the global economy, and reduce the risk of an inflationary overheat in the United States itself, giving the Federal Reserve room to ease policy more aggressively.

The greenback’s losses against its major counterparts are approaching the 1-percent threshold as we go to print, with the Mexican peso, euro, British pound, Australian dollar, and Canadian dollar advancing by the most in early trading. The benchmark for global borrowing costs—the ten-year Treasury yield—is holding near 4.57 percent, well above the 3.61 percent that prevailed ahead of the Fed’s first rate cut in September, but below Friday’s 4.61-percent close. US equity markets are marching toward new highs on improved prospects for global sales and domestic margin expansion.

Gains may not last. Major unknowns remain, with the policies outlined in the Post article clearly at odds with Trump's previous threats. The president-elect could easily reverse market moves in a single swipe on Truth Social, and currency traders will remain in sell-first, ask-questions-later mode for now.

The Canadian dollar outperformed its developed-market peers over the weekend after the Globe and Mail said that Prime Minister Justin Trudeau is planning to step down before Wednesday, but gaps are narrowing this morning as traders adopt a more nuanced view on the implications. If Trudeau resigns, the Liberal party may appoint a caretaker prime minister and run a convention to choose a new party leader, but this won’t bring an election materially closer than October’s drop-dead date. We think markets will ultimately welcome a win by Pierre Polievre’s Conservative Party—which has a massive lead in the polls—but considerable uncertainty remains around the degree to which his right-of-centre political stance will align with Trump’s and make tariffs less likely.

From a broader perspective, we should note that year-ahead outlooks from the major global banks—and ourselves—were dominated by a likely-unrealistic extrapolation of early December’s trading themes. Under the prevailing consensus, currency strategists generally expect the dollar’s exceptionalism to fade somewhat over the year ahead as 2024's repricing in growth expectations fails to repeat, with the economy decelerating only slightly, the Federal Reserve easing policy at a more gradual pace, and the incoming Trump administration delivering a more pragmatic set of policies than those espoused during the pre-election period. High inflation and stagnant growth are seen capping the pound’s gains, while the euro turns in a lacklustre performance as the European Central Bank cuts rates. Forecasters think the Canadian dollar, Australian dollar, and Japanese yen could stage modest recoveries while ultimately failing to fully recoup last year’s losses.

Events in the days ahead could bolster these assumptions.

Data releases in the US should align with the “no-landing” scenario that has emerged as the central case among economists. Tomorrow’s November Job Openings and Labor Turnover Survey should show postings increasing even as the quits rate declines slightly from October’s levels. The Institute for Supply Management’s measure of services activity might point to the economy’s biggest sector expanding at a slightly faster rate during the all-important holiday season. Wednesday’s Fed minutes will provide valuable insight into the deliberations that led to December’s “hawkish cut,” helping to quantify the extent to which officials were balancing realised economic data against expectations for policy shifts from the incoming Trump administration when updating their projections for the policy path. And Friday’s non-farm payrolls report—which is expected to show roughly 153,000 jobs added in December—could illustrate continued resilience in labour markets.

Tomorrow morning’s inflation update from Eurostat won’t provide a persuasive reason to slow the pace of rate cuts. Although headline consumer price growth in the common currency area likely remained elevated in December as unfavourable base effects lifted energy costs, underlying core measures probably remained relatively stable, setting the stage for renewed disinflation in the second quarter of 2025. Market pricing should remain consistent with a quarterly easing cadence from the European Central Bank over the year ahead.

Here in Canada, Friday’s job creation number could surprise to the upside, yet won’t provide much solace to policymakers who are bracing for upheaval ahead. The economy—already suffering from a debt-induced consumption shock—could easily tumble into recession if president-elect Donald Trump follows through on threats to impose 25 percent taxes on American consumers of the country’s exports, and central bankers seem inclined to buy insurance against such an outcome beforehand. Until deeper uncertainties are resolved, rate differentials will remain depressed, and loonie bulls are likely to lack motivation.

God may have created economists to make astrologers look good, but she also created currency strategists to make the economists look good. A review of last year’s record—in which the average gap between consensus forecasts and realised exchange rates exceeded 8 percent—and a glance at today’s headlines would suggest that it is foolhardy to use current expectations when planning for 2025.

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