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Trump’s Inauguration Day: Here’s what I’m looking for.
John J. Hardy
Global Head of Macro Strategy
Summary: Trump has promised to kick off his second term in office with “historic speed and strength to fix every crisis facing our country”. Markets will mostly react to the new Trump administration’s tariff plans.
The week begins with Trump’s inauguration address, and the incoming president has promised to deliver shock-and-awe with a raft of executive orders to kick off his second term in office. Tariffs are the chief initial concern for global markets, as a series of stories and in some cases, words directly from Trump himself in recent weeks have made very clear. Friday saw the latest headline from Trump that roiled global markets, this time a reference to a “very good” call with China’s president Xi Jinping in which he claimed that trade, TikTok and fentanyl were discussed. “President Xi and I will do everything possible to make the World more peaceful and safe!”. The market reaction was noncommittal after a flurry of USD selling on the idea that this rhetoric suggested Trump will be in a deal-making stance with China rather than a confrontational one. Remember that 2017 saw a massive drop in the US dollar as Trump was in deal-making mode.
Implied volatility for short-dated FX options is extremely elevated ahead of today’s Trump speech, with EURUSD 1-week volatility at 11.5% today and USDJPY 1-week at 12.5%, but EURUSD’s IV is more elevated relative to the recent baseline elsewhere. More elevated still is USDCAD vol, where 1-week implied was in the 5-6% range for most of 2024, but has spiked to 11.7% from below 7.5% a week ago. USDMXN 1-week vol has risen above 19%. Skew is tilted to USD strength outside of USDJPY.
Chart: USDCAD awaits Trump’s tariff intentions
USDCAD has traded nervously after the huge rally to new post-pandemic-outbreak highs above 1.4000, a rally that has been driven by both USD strength and Canadian weakness as higher rates were quicker to impact the Canadian economy and the Bank of Canada cutting cycle outpaced that of the Fed. Note the massive twice tested area above 1.4600 in USDCAD, a level that held in both early 2016 and in 2020. December’s monthly close, however, was the highest monthly close since 2003. CAD traders nervously await the shape of Trump’s tariffs and whether he moves broadly against all trading partners, possibly targeting Canada on border security mostly related to illegal drugs and for its low levels of defense spending. Given the anticipation here, an aggressive tariff imposition could see USDCAD could be trading 1.5000 in a few weeks, while a lack of tariffs could drive a CAD relief rally back to 1.4000, though options are extremely skewed to upside vol (premium for calls relative to puts for 1-week options is 3.75%).
What I am look for on Inauguration Day:
The market has its finger on the trigger to react to what Trump delivers today – or at least, FX traders have their fingers on the trigger. Equity market volatility looks remarkably complacent in relative terms, an interesting disconnect.
The chief concern for currency traders as noted above is Trump’s approach to tariffs, as the market is almost entirely in the dark on what he will deliver today. Here is what I will watch for:
Broad versus targeted? If Trump announces broad tariffs against all trading partners, even at a relatively modest level of say 10%, this is the most immediate USD-positive and risk negative outcome. Watch for CAD and MXN to be hit very hard, with EUR perhaps underperforming the JPY and GBP underperforming EUR. There could also be an even worse mix of broad and targeted, with Trump singling out individual countries (China especially of note if so) or individual and large product categories for higher tariffs on top of the broad tariffs. This would exaggerate the above reaction.
If the tariffs are not broad and only targeted, the market reaction may prove a bit muddled until it sorts through the implications, as especially large tariffs against significant import categories or important countries of origination like China can still trigger significant unease.
Ratcheting of tariffs? One idea that has been floated by US Treasury Secretary nominee Scott Bessent is an approach of starting tariffs at low levels and chiefly using them as a negotiation tactic, promising to ratchet tariffs higher from a low starting point – or even starting them at zero – before ratcheting them higher by 2% or 5% a month until the desired policy change from the counterparty has been made. The market may take any “gradual increase” as a positive, but this would seem misguided, as the tariff would still rise to significant level. And of course, while Trump may not deliver all of the specifics in his inauguration speech today, we could get a mix of all three of the above: broad and targeted tariffs, some of which will ratchet higher with regular increases unless the target nation responds as desired.
It is an awkward time for global markets to absorb the message from Trump, as US equity and bond markets are closed, with hours for futures trading also partially restricted. Not everything Trump and his team are doing today will be in the speech, as there will be too many executive orders with specifics for Trump to deliver in a single speech, so we’ll have to stick close to the newswires to get the full scope of an historic Day One for a new US president.
And we’ll need Tuesday’s action to assemble a fuller picture of the full circle market reaction for rates and for risk sentiment, although we will inevitably spend weeks and months watching the reality on the ground unfold, including how the rest of the world responds to the US’ new policy mix.
I’ll be back tonight after Trump’s inauguration speech with further comments.