Tariff Threats and Forex: Key Insights & What Traders Need to Know

The trading relationship between North American countries, the USA, Mexico and Canada, is of utmost importance to all three countries. Canada and Mexico are the United States’ first- and second- largest export markets, while the US remains the largest export market for both Canada and Mexico.¹

The US administration has long argued that existing trade agreements with Mexico and Canada have led to job losses and unfair competition for American businesses. By imposing tariffs, the government aims to level the playing field, encourage domestic production, and ultimately boost the US economy.

The announcement and subsequent postponement of 25% tariffs on Mexico and Canada has created a lot of uncertainty. Let us try and make sense of how markets could react moving forward, as well as the implications for the everyday consumer.

To understand how tariffs affect currency markets, it’s important to know their impact. Tariffs are a form of taxes on imported goods, and they can influence exchange rates in two main ways:

1. Trade Balances: Tariffs make imports more expensive and could boost exports, helping reduce trade deficits. If a country’s trade balance improves, its currency might become stronger.
2. Market Confidence and Economy: Tariffs can cause economic uncertainty, affect inflation, or slow down economic growth. These factors can make a country’s currency more volatile.

President Trump has so far lived up to his campaign promise of tariffs and ‘getting better trade deals’ for the US. During his first term as president, the US saw its overall share of government tax receipts from tariffs rise. However, this still remains a small part of the federal budget.

Historically, though, tariffs have thus far failed to arrest the mounting trade deficit in the US, as the country continues to buy more from abroad than it sells overseas.

The chart below shows that during the Presidency of Obama, Trump's first term and the Biden administration, the US trade deficit failed to narrow and continued to widen.

The chart above raises the question: Are tariffs the right move for the Trump administration to lower the trade deficit?

Mexico's economy is closely connected to trade with the US because of the US-Mexico-Canada Agreement (USMCA). Historically, tariffs on Mexican goods have had clear effects on the value of the Mexican peso (MXN).

Historical Context: In 2019, when the Trump administration threatened tariffs on Mexican imports, the peso dropped sharply, losing about 2.5% of its value in just one day. This happened because markets were worried about how tariffs could hurt Mexico's export-driven economy, especially its automotive and agricultural industries, which heavily rely on trade with the US.

Let us take a look at a USD/MXN chart, and focus on the impact of the tariff threat, which led to significant peso weakness in 2019.

Current Outlook: Should the US implement new tariffs or roll back the USMCA provisions, the MXN could face downward pressure. Conversely, increased trade flows through continued regional cooperation could bolster the peso.

On January 29, 2025, President Trump announced tariffs on Mexico but delayed the implementation by a month. This was down to a deal with Mexican President Claudia Sheinbaum regarding border security, among other things. Looking at the developments thus far, it appears that the Trump administration is using tariffs to secure better trade deals and other concessions.

This remains a double-edged sword, however, with more than 15% of all US imports coming from Mexico. The automotive sector in the US has already warned of the consequences tariffs may have on prices.

For context, the US imports around 36% of vehicles from other countries, with the big three US carmakers General Motors, Ford and Stellantis all having significant operations in Mexico and Canada.

Mexico's vehicle and parts exports have grown quickly in recent years, making it the largest trade partner in this sector. By 2024, these exports are estimated to be worth about $140 billion. This prompted US automakers to warn that prices could rise as much as $2000 for vehicles if tariffs are imposed.

Let us take a look at a USD/MXN chart, and focus on the impact of the tariff announcement over the weekend of February 1, which led to significant peso weakness.

Moving forward, market participants need to be aware that the Mexican peso, like most emerging market currencies, is highly sensitive to tariff related news. Market participants should keep a watch on the US-Mexico political developments and supply chain changes to get useful insights into possible movements in the value of the Mexican peso (MXN).

The Canadian dollar is strongly affected by trade with the US, as about 75% of Canada's exports go there. Tariffs on industries like aluminum and steel have directly and indirectly impacted the value of the Canadian dollar in recent years.

Historical Context: When the US put tariffs on Canadian steel and aluminum in 2018, the Canadian dollar (CAD) dropped slightly at first. But it partially bounced back thanks to higher crude oil prices, which are a major export for Canada.

Current Outlook: If US tariffs resurface or global demand for key Canadian exports weakens, the CAD could come under renewed pressure. President Trump has announced a 25% tariff on aluminum and steel, which could keep the Canadian dollar on the back foot. On the flip side, strengthened trade frameworks and surges in energy prices could provide a tailwind. Also, any exemptions made by President Trump of lower tariffs on Canadian imports could aid the CAD.

The Canadian dollar is closely linked to oil prices and is often termed a ‘commodity currency’. This means the CAD is prone to dual influences, trade disputes and fluctuations in energy markets. Market participants would be wise to keep an eye on developments there, which could help them navigate the Canadian dollar moves in the coming months.

The US imports around 58% of its aluminum and 25% of its steel from Canada, which means the recent 25% tariffs on these products will definitely exert downward pressure on the CAD. These tariff measures will take effect on March 12 unless any changes or exemptions are granted.

During his previous tenure, President Trump provided exemptions to countries like Canada, Mexico, EU and the UK. These exemptions have also been revoked, and yet I and many market participants are left questioning whether they will be instituted as the March 12 deadline approaches.

This is worth monitoring as any concessions or announcements moving forward will lead to CAD volatility.

The Eurozone’s economy, which relies heavily on trade from countries like Germany and France, has faced challenges due to tariffs. The euro (EUR) has often been affected by US trade policies, especially those targeting European cars and farm products. So far, we have not heard much regarding direct tariffs on the EU, but President Trump's rhetoric will no doubt be playing on the minds of European leaders.

President Trump has continuously taken shots at the EU regarding their trade surpluses with the US. Germany, for example, runs the third-highest trade deficit with the US after Mexico and Canada. Trump has started a detailed review of US trade relationships, and the report is expected on April 1, 2025. This will be an important time for the EU.

Historical Context: During Trump’s first term, the EU retaliated with its own tariffs on US aluminum and steel. To prevent things from escalating, the EU also threatened tariffs on US items like Levi’s jeans and Jack Daniel’s. Additionally, they agreed to buy more US liquefied natural gas (LNG) and soybeans. A similar strategy could happen again, with the EU possibly offering to buy more US LNG or military equipment. However, the big question is how much President Trump will focus on making trade deals in his second term.

Current Outlook: Continued trade disputes between the US and EU, or even potential tariff escalations related to carbon border taxes, could weigh on the euro. However, progress in trade agreements or a resurgence in the Eurozone's economic performance post-inflationary struggles may counterbalance these risks.

The Chinese yuan (CNY) was heavily impacted by tariff disputes, especially during the US-China trade war. When the US sharply increased tariffs on Chinese goods in 2018 and 2019, the yuan lost value. This happened because people expected China’s economy to slow down due to fewer exports.

Historical Context: During the height of the trade war in 2019, the Chinese central bank allowed the yuan to weaken past the critical 7.00-per-dollar level to offset the impact of US tariffs and support its exporters.

Current Outlook: Trade tensions between the US and China have lessened, but economic and political disagreements are still present. New trade restrictions could cause the Chinese yuan (CNY) to lose value again. However, China’s central bank often steps in to influence the currency, making it harder for traders to predict movements.

Moving forward, the Chinese yuan usually responds to trade policies through both market changes and government controls. The People’s Bank of China (PBOC) plays an important role in keeping the currency stable, so it’s important to watch their announcements.

The interplay between tariffs and currencies is unlikely to fade anytime soon. Here’s what traders should keep an eye on:

• Trade Negotiations and Agreements: The question for most traders is whether or not many of these tariff proposals will actually come to fruition. Keep an eye on developments between the US and trading partners, with deals probably leading to very little movement of the currency pairs in question.
• Geopolitical Developments: Unexpected political or social disruptions can amplify tariff-related movements, creating further volatility in currency markets.
• Economic Indicators: Should the proposed tariffs come into play, economic data will become even more important. GDP data releases and inflation will need to be monitored and may provide clues as to how currencies may perform for the rest of the year.
• Central Bank Actions: Comments by various Central Banks will be key as well. Many countries were eying rate cuts from their respective Central Banks in 2025, but as we have already seen with the Fed, tariff uncertainty or implementation will have a massive bearing on monetary policy.

Looking at tariffs and the big picture, I fail to see who wins from a tit-for-tat trade war. One thing that the data shows us is that everyday citizens and consumers are the ones who bear the brunt of tariffs in the form of higher prices for goods and services.

To elaborate on this, I will leave you with a good example. Over the last 30 years, US Presidents from Clinton to Biden have imposed tariffs on steel with the hope of reviving the industry in the US. However, the chart below shows that since 1990 US iron and steel mill employment has been on a steady trajectory to the downside.

The question then becomes, why would this time be any different?

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Footnotes

1 https://www.brookings.edu/articles/trumps-25-tariffs-on-canada-and-mexico-will-be-a-blow-to-all-3-economies/