Good morning. Measures of implied volatility are holding steady across financial markets, as the drumbeat of economic data slows and after the Trump administration’s threatened “economic D-Day” against Iran’s trading partners turned out to involve more rubber dinghies than landing craft. Treasury yields are edging lower (albeit from elevated levels), equity futures are advancing, and currency markets are firmly range-bound, with most major currencies down by less than 0.3% against the dollar since Friday’s close.
Oil prices are slipping, with both Brent and West Texas Intermediate down by more than 3% from yesterday. After threatening “the single greatest financial offensive ever marshalled against an adversary”, Treasury Secretary Scott Bessent last night announced sanctions on more than 60 entities linked to Iran—but stopped short of targeting banks and companies based in China, which buys 90% of Tehran’s oil and is believed to be a major supplier of the dual-use components behind its missile, drone and cyber forces. Markets had feared that a broader move might inflame tensions with Beijing and raise the risk of a widening in the conflict across the Middle East.
Perceived geopolitical tail risks have narrowed. Expectations for a full reopening of the Strait of Hormuz are little changed, and although some oil is getting through with American help, volumes are uncertain and global inventories keep falling. But investors are increasingly convinced that both sides want to avoid all-out military escalation, and are assuming the present standoff will hold for a while yet.
US-Canada trade relations took another turn for the worse yesterday as President Trump threatened to impose 50% tariffs on cars, car parts, and steel from Canada beginning in January, and Ontario Premier Doug Ford suggested that Canada could cut electricity and critical mineral supplies to the US. Duties on Canadian cars currently stand at 25%, further diluted by their American content, while those on steel are already at 50%. The escalation follows a turbulent few days: Canada walked away from talks on Friday night, Trump imposed 50% tariffs on a wide range of Canadian goods on Saturday, and Prime Minister Mark Carney vowed to implement retaliatory measures, including “dollar-for-dollar” levies on US imports and support for businesses caught in the crossfire. Ford and Trump spent much of yesterday trading insults.
We don’t want to sugar-coat the risks for Canada. An intensified trade war will hurt the country more than the US. The Canadian economy is more export-dependent, with a larger share of output and employment devoted to selling into international markets, and there is no realistic prospect of redirecting much of that trade outside North America any time soon. Businesses will close and jobs will be lost if the conflict drags on, and uncertainty will continue to hamper business investment and consumer spending. Counter-tariffs will not help: in Canada, just as in the US, they are effectively taxes on domestic consumption: they raise the cost of living while doing little to shift trade balances or improve overall economic welfare.
Awareness of this forbidding calculus has prompted investors to mark down Canada’s growth prospects and pare back expectations for monetary tightening from the Bank of Canada, generating a degree of currency underperformance*. But there is strong evidence that the Canadian public is willing to bear considerable economic pain to defend the country’s interests, giving Mark Carney and his team a degree of negotiating leverage. This—combined with signs of yield-management desperation from the US Treasury—is translating into a fascinating** asymmetry in options-market positioning, with traders paying more for hedges against weakness in the greenback than the Canadian dollar.
To put it more bluntly: for all the sturm und drang, markets still expect a deal between the US and Canada. In the near term, that means the big risks in currency markets—in either direction—are likelier to come from Trump’s social-media feed than from today’s consumer confidence numbers, tomorrow’s release of the Fed’s preferred inflation measure, Nvidia’s earnings, or Kevin Warsh’s Jackson Hole address on Friday morning. I wish it were otherwise***, but there it is.
*Although, it should be noted, not outright declines: the Canadian dollar is still up more than 1% against the dollar this month, roughly the same as the pound and euro.
**Your mileage may, admittedly, vary.
***There was a time, dear reader—barely remembered now—when economic fundamentals were important in driving currency markets.