Tariff Turbulence: Will Trump Target Canada and Mexico?.

• Trump’s Tariff Deadline Looms: Canada and Mexico face a potential 25% tariff tomorrow, with markets anxiously awaiting confirmation. CAD and MXN remain under pressure, while the USD strengthens.
• Potential Last-Minute Deals: Commerce nominee Howard Lutnick hinted at exemptions if Canada and Mexico meet US border demands, leaving room for de-escalation.
• ECB Holds Course Despite Policy Leak: The ECB cut rates as expected and remains dovish, though a leaked report hints at a slight hawkish shift in March guidance.
• Trump’s BRICS Warning: Trump threatened 100% tariffs on BRICS nations attempting to create a new reserve currency, reinforcing USD dominance.
• Key Economic Data Ahead: US PCE inflation data and job market signals will influence Fed policy and broader FX trends in the coming days.

USD: High Stakes for North American Trade
This weekend marks a pivotal moment for US trade policy as President Donald Trump’s tariff threats against Canada and Mexico face a critical deadline. Both nations are set to encounter a 25% tariff by tomorrow, and while markets had not fully priced in the risk, Trump’s reaffirmation of his protectionist stance caused a selloff in CAD and MXN, boosting the US dollar. Investors remain cautious, but if tariffs are formally imposed, both currencies could see substantial downside pressure.

Earlier this week, Trump’s nominee for Commerce Secretary, Howard Lutnick, suggested that Canada and Mexico might avoid tariffs if they complied with US border requests. A possible resolution could involve last-minute agreements, either lifting or suspending the tariff threat.

How the administration handles this situation will set a precedent for Trump’s broader trade policy, potentially impacting global FX markets. If the tariff threat does not materialize by tomorrow, the dollar may weaken against CAD, MXN, and other currencies exposed to tariff risks, including AUD, NZD, and EUR. Investors may conclude that Trump prefers to use tariffs as leverage in negotiations rather than implementing them outright.

On the data front, today’s US core PCE report is expected to show a 0.2% rise for December, with the possibility of an upside surprise. Meanwhile, Q4 GDP came in softer than anticipated at 2.3%, down from Q3’s 3.1%, but consumer spending remained resilient. Jobless claims unexpectedly dropped for the week ending January 25, indicating minimal immediate employment impact from the California wildfires.

For now, tariff developments will likely drive USD movement. A lack of updates on Canada and Mexico by the end of today could signal a stronger dollar as markets begin pricing in a higher likelihood of tariffs being imposed.

EUR: ECB Sticks to the Script Despite Policy Leak
The European Central Bank cut interest rates by 25 basis points yesterday, aligning with market expectations. The Governing Council maintained a data-dependent, meeting-by-meeting approach while reinforcing its dovish stance due to optimistic disinflation forecasts and sluggish economic growth. Unlike the Bank of Canada, which tied future rate decisions to US trade policy, the ECB appears committed to easing irrespective of Trump’s tariff actions.

The most notable development was a media leak indicating that the ECB plans to remove the term “restrictive” from its rate guidance in March. While this could be interpreted as a slightly hawkish shift, the overall communication remains dovish, making a significant market reaction unlikely until further clarification on the neutral rate emerges on February 7.

Upcoming economic data could shift expectations. Today’s flash CPI estimates for France and Germany are in focus, with forecasts suggesting a rise to 1.5% in France and a stable 2.6% in Germany. Core inflation details will be key, but only a substantial upside surprise is likely to drive the euro meaningfully higher, as ECB President Christine Lagarde has signaled tolerance for moderate inflation fluctuations in early 2025.

EUR/USD remains closely tied to the dollar’s tariff-driven movements. If Trump proceeds with tariffs against Canada and Mexico, EUR/USD could drop below 1.030 due to USD strength and heightened trade concerns.

GBP: Sterling Holds Ground Amid US Trade Uncertainty
The British pound is trading within a tight range above the key 1.2400 support level against the US dollar in Friday’s European session. Despite rising USD demand fueled by Trump’s tariff threats, GBP/USD remains stable.

Trump’s latest comments on his social media platform, TruthSocial, reaffirmed his intent to impose 25% tariffs on Canada and Mexico starting Saturday, along with a 100% tariff on BRICS nations if they attempt to introduce a new global currency alternative to the USD. Trump declared, “BRICS will never replace the US dollar in international trade,” warning that any country attempting to do so should “say hello to tariffs and goodbye to America!”

Traders fear these aggressive tariff policies could stoke inflation, forcing the Federal Reserve to maintain higher interest rates for longer. On Wednesday, the Fed paused its rate-cut cycle, keeping borrowing costs at 4.25%-4.50%. Fed Chair Jerome Powell emphasized that future adjustments will depend on tangible inflation progress or signs of labor market weakness.

Later today, markets will closely watch the US Personal Consumption Expenditures (PCE) Price Index release at 13:30 GMT. The core PCE inflation rate, the Fed’s preferred gauge, is expected to show a monthly increase of 0.2% from November’s 0.1%, with annual inflation steady at 2.8%.