Trump's tariff threats signal the start of a wild ride in currency markets

• Trump said Monday he would sign an executive order on Jan. 20 imposing a 25% tariff on all goods coming from Canada and Mexico, a move that could violate the terms of a regional free trade agreement.
• The former president, who has previously called tariff "the most beautiful word in the dictionary", also said he plans to raise tariffs by an additional 10% on all Chinese products coming into the U.S.
• The announcements prompted a knee-jerk reaction in currency markets, with the U.S. dollar rising more than 2% against the Mexican peso and notching a four-year high against the Canadian dollar.

President-elect Donald Trump's vow to implement additional tariffs on China, Canada and Mexico on day one of his presidency signals the start of a wild ride in currency markets, strategists say, warning it would be risky for investors to underestimate the impact on foreign exchange rates.

Trump said Monday he would sign an executive order on Jan. 20 imposing a 25% tariff on all goods coming from Canada and Mexico, a move that could violate the terms of a regional free trade agreement.

The former president, who has previously called tariff "the most beautiful word in the dictionary," also said he plans to raise tariffs by an additional 10% on all Chinese products coming into the U.S.

The announcements prompted a knee-jerk reaction in currency markets, with the U.S. dollar rising more than 2% against the Mexican peso and notching a four-year high against the Canadian dollar.

"I think the first reaction here is that investors should get ready for a wild ride in FX volatility," said Kamakshya Trivedi, head of global foreign exchange, interest rates and emerging markets strategy research at Goldman Sachs.

The U.S. dollar index, which measures the greenback against six major currencies, was 0.1% higher at 106.9 at 3:50 p.m. London time on Tuesday. The index closed 0.6% lower in the previous session as investors welcomed hedge fund manager Scott Bessent as Trump's pick for U.S. Treasury chief.

The euro and pound sterling were both trading little changed against the dollar, paring earlier gains.

"This is going to be something that we are all going to have to get used to. It is going to be volatile moves in FX markets because, you know, currencies are to some extent the primary means of responding to any sort of tariff announcement," Trivedi told CNBC's "Street Signs Europe" on Tuesday.

Goldman's Trivedi said investors should be prepared for wild swings in currency markets over the coming months — but also over the long term, since tariffs are highly likely to be a prominent feature of Trump's return to the White House.

There are a few unknowns for investors, Trivedi said, citing the extent to which Trump's tariffs could be used simply as a negotiating tool, whether they are reflective of a "maximalist" position or whether the impact of tariffs have already been priced in by financial markets.

"But I do think at the end of the day, we are going to see an increase in tariffs on a number of economies, primarily China, and I think that is going to elicit a stronger dollar response on a broad basis," Trivedi said.

'A large bargaining stick'

The former president's tariff announcements via social media platform Truth Social were far lower than some of his campaign pledges, but strategists remain wary about the potential for further announcements and the prospect for retaliatory measures.

Trump has previously suggested he could implement a blanket 20% tariff on all goods imported into the U.S., with a tariff of up to 60% for Chinese products and one as high as 2,000% on vehicles built in Mexico.

"The market seems to expect this trade war to be effectively just a long negotiation process, where the U.S. gets something and China, Europe, Mexico probably have to give something," Luca Paolini, chief strategist at Pictet Asset Management, told CNBC's "Squawk Box Europe" on Tuesday.

"The point that we are making here, is that there is a possibility that Trump will implement significant tariffs [and] there will be a lot of pressure in China and Europe, and we know how this will end," he added.

Strategists at Dutch bank ING said Tuesday that while Trump's tariff threats could be seen as a negotiating tactic before he takes office in January, it would be risky for investors to underestimate the impact on currency markets.

"Whilst most in the market assume that Trump will be using tariffs as a large bargaining stick — in this case to tighten US border controls — we would be careful of dismissing their market impact as some grandstanding," ING's Chris Turner said in a research note.

"If 25% tariffs came close to seeing the light of day in Mexico, USD/MXN would be a 24/25 story, not just 21. We already think the currencies of Mexico and Canada will have a tougher Trump 2.0 than they did during his first term," he added.

Cautious outlook

Similarly, strategists at Citi expect the incoming Trump administration to use tariffs as a bargaining tool.

"We are still reasonably cautious. I mean, obviously realizing that one headline can make the [Mexican] peso move by 1.5% to 2% like it did overnight," Luis Costa, global head of emerging markets strategy at Citi, told CNBC's "Squawk Box Europe" on Tuesday.

"To us, it is absolutely obvious that the Trump administration will use tariffs as one important lever to negotiate with [Mexican President Claudia] Sheinbaum's government. It is probably something that is more about negotiation rather than about imposing tariffs," he added.