Market News

The US$7.5 trillion-a-day currency market has become a focal point for investors as President Donald Trump enacts the biggest U.S. tariff increases in a century. Changing global trade patterns affect the outlook for growth and inflation, which in turn can impact exchange rates. Here’s how it all works.

How do tariffs impact currencies?

If a country’s products are subject to U.S. import duties, they will become more expensive for American consumers. That reduces demand for those products and for the currency that’s required to buy them — hitting that currency’s value and boosting the U.S. dollar. By the same token, if other countries impose retaliatory tariffs on imported U.S. goods, demand for dollars may fall.

Tariffs can also lead to inflation in the nation imposing them as imported goods become more expensive. This in turn may boost expectations that the country’s central bank will tilt toward higher interest rates. And higher rates boost returns on local bank deposits, adding further support for the currency.

However, it gets more complicated if tariffs lead to a more prolonged bout of inflation. This eventually dampens consumer spending and causes businesses to spend less due to higher input costs. That can reduce the country’s appeal as an investment destination and therefore the demand for its currency.

Trump has acknowledged to Americans there could be a “little disturbance” ahead in the U.S. economy but defended his plan, saying it will raise trillions in revenue and rebalance trading relationships he called unfair.

Who benefits and who loses when currencies are volatile?

Investment banks and brokerages can profit from swings in currencies as it creates more opportunities to capitalize on price differences. But for companies that trade across borders, volatile exchange rates make it costlier to do business as they’re forced to spend more to hedge their currency exposure.

After a long period of relative calm in currency markets, banks have been hiring more options traders, and hedge funds have increased their positions in expectation that Trump’s tariffs will cause sizable moves in exchange rates. Investors who buy overseas assets are also exposed to currency risk and many have been increasing their hedging, according to Jefferies.

Are currency markets more volatile now?

Aside from some pronounced moves in individual currencies, the overall level of foreign exchange volatility has been relatively contained since Trump took office. Tariff threats have turned into action against Canada, Mexico and China but there’s still a lot of uncertainty around whether negotiations could see tariff measures pared back. The White House has already given automakers in Mexico and Canada a one month exemption and Trump is considering offering relief on some agricultural products. That could send the Mexican peso and Canadian dollar rebounding from recent lows.

What have Trump’s tariffs done to the U.S. dollar?

The Bloomberg Dollar Spot Index surged to its strongest level in over two years at the beginning of February on expectations that Trump’s tariff agenda will fuel inflation and delay Federal Reserve interest-rate cuts. But a string of recent weak economic data saw investors change their focus to the outlook for growth. Markets were still positioned for further dollar strength in early March, though money managers were having to grapple with crosscurrents that could alter the outlook, including an aggressive ramp up in defense spending in Europe and retaliatory tariff measures from other regions.

What has been the reaction in the Canadian dollar and Mexican peso?

Canada and Mexico were among the first countries to be on the receiving end of Trump’s tariff threats and both currencies plunged against the dollar when the levies were announced in early February. Canada’s so-called loonie touched 1.45, its weakest versus the dollar in over two decades, while the Mexican peso slumped to levels just shy of 21 per dollar, the lowest since 2022. Since then, there’s been some volatility amid implementation delays and negotiations, but foreign exchange forecasters broadly anticipate the currencies will remain near their recent lows in the coming months.

What about the Chinese yuan?

The yuan came under the spotlight amid market chatter that Beijing may have to devalue its currency to blunt the impact of Trump’s new tariffs on Chinese imports and boost an already fragile economy. During the last trade war, the People’s Bank of China allowed the yuan to slide to its weakest since the global financial crisis as it sought to support local exporters.

Lately, the PBOC has ramped up its defense of the currency instead, underscoring its tough stance on maintaining a stable yuan. The central bank’s supportive measures — such as its steady daily reference rates, increases in offshore bill sales, delays in interest-rate cuts and a pause of government bond buying — have helped to support the offshore yuan after it fell close to a record low in January.

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Alice Atkins and Vinícius Andrade, Bloomberg News

--With assistance from Zijia Song, Wenjin Lv and Anya Andrianova.