The Canadian dollar (CAD) has bounced back from a 22-year low, regaining much of its value against the U.S. dollar as markets adjust to the possibility that Canada may receive a temporary reprieve from U.S. tariffs. On Monday, the loonie recovered from its lowest point in two decades, hitting 1.4793 against the U.S. dollar, a level not seen since April 2003. It has since been trading at 1.4590 to the U.S. dollar, a 0.5% decline, or 68.54 U.S. cents.
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This recovery comes after U.S. President Donald Trump postponed the implementation of tariffs on Mexico for a month. This decision followed Mexico’s commitment to deploy 10,000 National Guard personnel to curb the flow of illegal drugs across its northern border. The possibility that Canada could receive similar relief has contributed to the loonie’s resurgence.
The Canadian Dollar’s Rebound: Market Anticipations and Government Outlook
Karl Schamotta, Chief Market Strategist at Corpay, noted that the euro, Canadian dollar, and Mexican peso have all seen notable surges, driven by market expectations of a similar tariff delay for Canada. However, a senior Canadian government official mentioned that Canada does not anticipate receiving the same month-long reprieve from U.S. tariffs that Mexico was granted.
On the weekend, President Trump imposed sweeping 25% tariffs on imports from Canada and Mexico, with tariffs on Canadian goods scheduled to take effect Tuesday. In response, Canadian Prime Minister Justin Trudeau has indicated that Canada will retaliate with 25% tariffs on $155 billion worth of U.S. goods. The imposition of these tariffs follows the Bank of Canada’s decision to cut its benchmark interest rate by 25 basis points, reducing it to 3%, amid concerns about the adverse economic impact of the ongoing trade war. The likelihood of further rate cuts in March has increased, with market expectations now predicting an 80% chance of another rate reduction.
Despite a slight uptick in Canadian export orders, which saw their first gain in 17 months, industrial activity in Canada slowed in January due to the looming uncertainty surrounding U.S. trade tariffs. This cautious outlook has led to a decline in Canadian bond yields, with the 10-year yield dropping to 2.879%—its lowest level since September 2018—before recovering slightly to 2.929%.
Forecasting the Canadian Dollar Amid the Trade War
In December, analysts predicted that the U.S.-Canada trade war could push the USD/CAD exchange rate to 1.50. The ongoing tariffs and the Bank of Canada’s response remain key factors shaping the future of the Canadian dollar. While the situation presents risks to the Canadian economy, markets are closely monitoring signs of de-escalation, which could provide an opportunity to buy the loonie at a discounted rate. The U.S. government’s imposition of tariffs on Canada and Mexico signals a possible abandonment of the U.S.-Mexico-Canada Agreement (USMCA) deal, which was personally negotiated by President Trump in 2019.
The first round of U.S. tariffs, set to go into effect Tuesday, will impose a 25% levy on all non-oil exports from Canada to the U.S., totaling approximately $311 billion. Oil exports, however, will face a lower 10% tariff. Canada has already imposed retaliatory tariffs on U.S. goods, with the first round of tariffs (valued at $20 billion) scheduled to begin, followed by a second round (worth $85 billion) in 21 days.
Bank of Canada’s Economic Projections: Inflation and Growth Impact
Estimating the economic impact of U.S. tariffs on both Canada and the U.S. is complex, as this situation is unprecedented in recent history. The Bank of Canada’s (BoC) January monetary policy report highlighted the potential effects of a trade war on Canada’s GDP, inflation, and overall market stability. According to BoC’s projections, Canadian growth could slow by 2.5 percentage points in the first year due to the U.S. tariffs. However, after three years, the negative impact on growth is expected to dissipate, assuming no further escalations.
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Inflation is expected to respond more gradually. In the BoC’s baseline scenario, consumer prices will experience little to no impact in the first year. However, by the second and third years, inflation may rise by 0.5 and 1.0 percentage points, respectively. The Bank acknowledges the risks of a more immediate inflationary shock, with an alternative scenario suggesting that inflation could increase by as much as 0.7 percentage points in year one and 1.3 percentage points in year two.
Navigating Uncertainty
As the trade war between the U.S. and Canada intensifies, the future of the Canadian dollar remains uncertain. While the loonie has shown signs of recovery, much depends on the Bank of Canada’s policy response and the trajectory of U.S. tariffs. The economic ramifications are far-reaching, with both inflation and growth expected to be significantly impacted in the short to medium term. As the situation unfolds, investors will continue to closely monitor any signs of trade war de-escalation and potential economic shifts that could influence the value of the Canadian dollar.
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