Currency markets shrug off Trump’s tariff threats, but risks remain

Measures of expected short-term currency volatility, including for the euro and the Mexican peso, have declined since Trump’s inauguration in January.

Currency markets are showing increasing scepticism toward Donald Trump’s tariff threats, raising the possibility of sharp market swings if the US President moves ahead with his proposed trade levies against China, Canada, and Mexico next week, as reported by the Financial Times.

Market reactions remain muted

Trump’s latest announcement targeting the EU and China briefly unsettled the euro and other currencies of key US trading partners on Thursday. However, the impact was less dramatic than previous market fluctuations seen earlier this year when the president initially detailed his tariff plans. Measures of expected short-term currency volatility, including for the euro and the Mexican peso, have declined since Trump’s inauguration in January.

“Having been burned on tariff trades already this year, investors are less reactive to unsupported tweets and political rhetoric,” Jerry Minier, co-head of G10 forex trading at Barclays, told the Financial Times.

Investor scepticism grows

While previous tariff announcements sent shockwaves through the currency markets, reactions have since become more restrained. On February 3, the dollar surged against major trading partners following Trump’s tariff announcement on Mexico, Canada, and China, only to reverse those gains by the end of the day after the president postponed the tariffs against Mexico and Canada.
Akshay Singal, global head of short-term interest rate trading at Citigroup, noted that the currency market has moved from “trusting and believing” Trump’s trade threats to taking a more cautious approach. “Previously, it was ‘I believe what you tell me,’ and now it is ‘show me,’” he said, referring to investor sentiment.

Despite the looming trade deadlines, the Financial Times reported that measures of expected volatility in key currency pairs have unwound significantly. Investors’ expectations for swings in the euro-dollar market over the next month have dropped by about 20% since mid-January. The volatility index for the Mexican peso has nearly halved from levels seen during the US election last year, while expectations for Canadian dollar fluctuations have also declined from early February peaks.

Market complacency could pose risks

Despite muted responses, some analysts warn that the market may be underestimating the potential economic fallout from tariffs. “Our models indicate that the tariff premium has unwound in recent weeks with little now priced in key [currency pairs],” Goldman Sachs said in a note on Friday.

A currency trader at a major European bank told the Financial Times that market activity has slowed significantly. “Trump will shout about some tariffs, row back from those announcements, the White House will say something totally contradictory, and then Trump might post the opposite on Truth Social 10 minutes later,” the trader said. “You can’t trade that.”

Potential for sharp market corrections

While currency and bond markets remain relatively calm, some investors fear that the lack of response could set the stage for sharper corrections if Trump follows through on his threats. “The day Trump does follow through [on blanket tariffs], there would be a knee-jerk reaction because most people think it is not priced in,” said Finn Nobay, a trader at investment firm Payden & Rygel.
The Financial Times also highlighted that the bond market, which initially reacted to tariff fears by pushing yields higher, has also cooled. The ICE BofA Move Index, a measure of expected Treasury market volatility, remains well below its highs from before the US election.

“You would think volatility would be higher given how little clarity the market has now, but the market has become numb to it, until [investors] actually see the path forward,” said Gennadiy Goldberg, head of US rates strategy at TD Securities.