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HSBC's FX strategy team recommends buying the U.S. dollar against the Canadian dollar (USD/CAD) in anticipation of tariff-related volatility as the March 4 deadline for U.S. tariffs on Canada approaches.
The bank argues that the lack of a U.S. dollar premium relative to rate differentials has created conditions for a significant move higher should trade tensions escalate.
While markets are currently pricing in a benign outcome, HSBC strategists warn that the imposition of broad 25% tariffs on Canada, should negotiations fail, could lead to a sharp appreciation in the greenback.
CAD is seen as being particularly vulnerable: "This currency faces the most immediate deadline among the many swirling in that U.S. trade policy fog," says HSBC strategist Daragh Maher.
"USD-CAD has fallen even lower than rate differentials would imply, meaning not only has the USD premium disappeared, but the CAD is enjoying a premium instead," he adds.
U.S. President Donald Trump has signed executive orders imposing tariffs on imports from Canada, Mexico, and China. The tariffs were initially set to take effect on February 4, 2025. However, following negotiations, the tariffs on Canadian and Mexican imports were paused for 30 days, delaying their implementation until March 4, 2025.
CAD has been drifting higher since the postponement, but FX strategists are warning that volatility risks spiking again.
A further delay in the tariff decision could lead to a modest weakening of the USD, but HSBC sees a greater likelihood of upward pressure on the currency if tariffs take effect.
HSBC notes that upcoming economic data, including Canadian GDP figures on Feb. 28 and labour market data on March 7, could weigh on the loonie. Markets currently assign a 42% probability to a 25-basis-point rate cut by the Bank of Canada at its March 12 meeting.
Beyond Canada, HSBC sees the euro (EUR) as another currency vulnerable to U.S. trade policy risks, but its downside potential may be mitigated by optimism over potential Ukraine peace talks. Meanwhile, the British pound (GBP) faces challenges from weak domestic growth and potential fiscal tightening in the UK’s March budget.
The USD/CAD pair was last trading around 1.4228, in line with HSBC's entry level for its recommended long position that targets 1.4040.
Strategists say lower global commodity prices and a 'dovish' Bank of Canada policy stance are additional factors that would exacerbate the move lower in CAD.