How Trump’s Tariffs can Impact the Forex Markets

President Trump halted the tariffs on Mexico and Canada for 30 days on February 3, 2025, even while Wall Street was bracing itself for the impact. In case the border negotiations do not work out, Donald Trump may go ahead and execute the 25% additional tariffs on two of America’s three largest trade partners. This is set to impact 50% of the country’s imports. China, Mexico and Canada account for $1.3 trillion worth of imports into the US, which may decline by 15%. Tariffs have a wider impact than just the trade numbers. They also influence foreign exchange rates.

Correlation Between Tariffs and Forex Rates

Tariffs affect trade flows across nations, which, in turn, impacts the demand for a currency. Historically, a positive trade balance results in heightened demand for the domestic currency. However, with increased tariffs, imports decline. This may adversely impact the exporting country’s GDP and lower the demand for its currency. A decline in demand for a foreign currency supports the domestic currency. Notably, retaliatory tariffs, as threatened by America’s neighbours, potentially counterbalance the impact on both currencies involved.

How Tariffs Could Impact Various Currencies

The four most impacted currencies in the US-inflicted trade war will be:

Mexican Peso

The peso had declined 2.9%, approaching a three-year low, after Donald Trump signed the executive order. However, the news of the suspension of the orders for 30 days supported the currency, which gained 1.9%. Investors are likely turn bearish on the Mexican peso if the tariffs went through, leading the currency to decline by 10% to 20%.

This is because the implementation of 25% additional tariffs on Mexican imports may adversely affect the economy. Although the Bank of Mexico (Banxico) might be forced to halt its monetary easing cycle, it is unlikely to halt the peso’s decline. Depreciation in the peso will make purchasing non-tariffed goods cheaper for the US, further exacerbating the trade imbalance. Additionally, investments in supply chains, nearshoring and manufacturing may decline in Mexico, as could job creation. This could push the Mexican economy into a recession.

Canadian Dollar

The Canadian dollar hit its lowest since March 2020 against the USD at 1.4515 after President Trumps signed the executive order. However, it recovered quickly after tariff implementations were delayed. The US imports oil, lumber, wood and cement from Canada. If the tariff rates are applied without exception, oil prices in the US will surge between $0.30 and $0.40 per gallon for the consumer. That is if the import volume does not decline.

While CPI may rise in the US, the Canadian economy will suffer greater damage. Being heavily dependent on US imports, the nation might fall into the clutches of recession within a few months. The Loonie may depreciate below its two-decade low, falling to the range of C$1.45 to C$1.50. However, by the end of 2025 or the beginning of 2026, the Loonie may recover, exerting downward pressure on USD/CAD.

Euro 

The EUR/USD declined to its November 2022 levels due to tariff fears in the first half of January 2025. It is expected to reach parity by mid-2025. The Euro Area’s economy is already facing growth risks. Donald Trump’s indications that the region could be next in the line of tariff fire has intensified the fear sentiment. The bloc’s growth could be limited to only 0.7% in 2025. A 10% tariff has the potential to lower output in the Euro Area by up to 1% over a three-year period.

Combined with the increasing interest rate differential between the US and EU, the USD may remain more attractive than the EUR for investors. Notably, the EUR/USD is the perfect example of shifts in investor sentiment and economic growth outlook having a deeper impact on a forex pair than tariffs. This means the EU may go into recession. The foreign exchange rate for the EUR/USD and GBP/USD may reach 0.97 and 1.20, respectively, by the end of 2025.

Chinese Yuan

The Chinese economy is only loosely coupled with trade. Only 37% of the nation’s GDP depends on imports and exports, which means the impact of tariffs will be low. Moreover, the US accounts for only 15% of China’s export income, while its share of global trade has risen over the past decade. Yet, the outlook for the yuan is bleak. Since Donald Trump’s victory, the offshore yuan declined over 3% while the onshore yuan hit a 16-month low in January 2025. One of the major reasons is that the Red Dragon is unable to achieve its growth targets despite multiple economic stimuli by the government.

The PBoC protects the value of the yuan using fixed-rate guidance. As of January 2025, the value of the currency is set at around 7.20 per dollar. Consequently, significant depreciation in the yuan is unlikely. While China would prefer that it stayed that way, the USD/CNY will remain volatile and is forecasted to reach 7.50 yuan per US dollar.

To Sum Up

• Trump’s tariffs will weigh on the currencies of America’s trade partners.
• The Mexican peso may depreciate up to 20%.
• The Canadian dollar may weaken against USD.
• The EUR and GBP may also decline against the US dollar in 2025.
• CNY is likely to remain volatile yet resilient despite the pressures of a trade war.

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