It could have been worse

The Trump administration just delivered a gut punch to FX markets, rolling out more draconian tariffs than many had priced in. The immediate reaction? A surging dollar, as traders recalibrate for weaker global growth and diminished chances of Fed rate cuts. Volatility is cranking higher, and with markets now headline-driven, every whisper out of Washington will have traders on edge.

But here’s where it gets interesting—the betting markets, where traders love to lurk on platforms like Polymarket, are leaning toward a short-lived trade war. Odds are 59% that Trump pulls tariffs on Canada by May, and Mexico is a literal coin flip. That expectation may explain why USDCAD didn’t rip higher (i.e., above 1.4900); instead, it hit profit-taking mode after its initial spike.

So far, the FX market’s reaction to Trump’s tariff shockwave has been surprisingly tame, considering the massive trade war escalation set to go live on Tuesday. USD/CAD has climbed just over 1%, and USD/MXN is up just north of 2%—a measured move rather than an outright panic surge.

What gives? Traders still hope that Trump could pull the plug at the eleventh hour. But let’s be honest—hope is not a strategy. With zero signs of a last-minute reversal and time running out fast, the market’s complacency could get shattered instantly.

The clock is ticking. If reality catches up, USDCAD will likely spike again.

The FX market reaction has been textbook risk-off, with a defensive surge in the U.S. dollar sending the DXY gapping over 1% higher. The biggest one-day casualties? Commodity currencies—those most exposed to global growth risks—are getting hammered.

The New Zealand and Australian dollars are taking an even harder hit than the Canadian dollar as traders dump risk-sensitive assets. Meanwhile, safe-haven flows trickle back into the Japanese yen and Swiss franc on those commodity currency crosses. Hence, the yen and swissy outperform amid the overall currency meltdown as investors scramble for shelter.

The fear trade is also driven by a 2% plunge in S&P futures, fueled by concerns that U.S. supply chains could snap under tariff pressure, slashing corporate profitability and rattling broader risk sentiment.

The bond market isn’t sitting idle either. The U.S. yield curve is flattening fast, with investors erasing 8 basis points from the Fed's easing expectations for this year on the view that tariffs are inflationary. At the same time, 10-year Treasury yields are sliding, reflecting growing recession fears today, but tomorrow, not far down the road, their fears could pivot to inflation fear, or worse case for stocks, stagflation fears.

This flatter yield curve is a double whammy for risk: It reinforces dollar strength while piling pressure on growth-sensitive currencies. With inflation concerns clashing with recession risks, the FX market is fully locked into a high-volatility, headline-driven cycle, and traders are bracing for the next big move.

The following 24 hours could be pivotal, with investors hanging on every whisper out of Washington. Will a high-stakes phone call between Trump and his Canadian and Mexican counterparts flip the script? Today's odds of a breakthrough are slim, but that won’t stop markets from hanging on to every rumour and headline. However, we must respect betting market odds for no reason other than the Wall Street traders who play them.

Meanwhile, the real battleground is unfolding in equities and FX. The key question: Do U.S. stocks crater enough to force the Fed’s hand into a more dovish stance? If that happens, the Japanese yen won’t just dominate on the crosses—it could start overpowering the dollar itself. But this is nothing short of a bloodbath for growth-sensitive and commodity-backed currencies—and there’s no relief in sight.

And let’s not forget the canary in the coal mine—U.S. automakers. Wall Street is glued to their every move today, as their reaction could set the tone for broader market sentiment. The stakes are massive, the volatility is brutal, and the next move could be just one headline away. Strap in—this is trade war trading at full throttle.

My trades

This was clean-cut euro negative. Those all-important EUR/USD two-year rate differentials have widened by 20 basis points over the past two sessions as investors price less Fed easing and more ECB dovishness.

The risk premium for a full-blown trade war is now firmly embedded in pricing, and while there’s a technical upside gap to 1.0350, that only fills if we get:

• Some kind of diplomatic breakthrough in North America today.

• A brutal equity market selloff that triggers forced dollar unwinds from a market already overloaded with long-dollar positions.

In China, USDCNH eased slightly after a WSJ report downplayed the likelihood of a yuan devaluation. As the yuan’s reaction wasn’t as aggressive as expected, we took a profit on our USDCNH long at 4.3625 and our EUR/USD short at 1.0225. Given the interconnectedness of these trades, it was the right time to lock in gains for today.

Bottom line: EUR/USD remains under pressure, but the next major move hinges on how much deeper this trade war spiral goes—or if something unexpected shakes up positioning in the dollar trade. Strap in, because this volatility isn’t cooling down anytime soon.