Canadian Dollar's Vulnerability: Markets Overlook Looming CUSMA Threat
While the Canadian dollar has enjoyed recent strength against its American counterpart, financial strategists are sounding alarms about a significant risk that currency markets appear to be overlooking. According to analysts, traders may be dangerously complacent about potential outcomes from the upcoming Canada-United States-Mexico Agreement review, with a negative result potentially driving the loonie back toward 70 cents against the U.S. dollar.
Current Currency Dynamics Mask Underlying Weakness
Mirza Shaheryar Baig, a foreign exchange strategist for Desjardins Group, explains that the Canadian dollar's recent gains have little to do with confidence in Canada's economic fundamentals. "Rather than reflecting economic strength, recent moves appear to be driven by traders unwinding large short positions on the Canadian dollar," Baig notes. "For the first time in three years, positions have switched to net long."
The greenback has faced pressure throughout 2025 and into 2026 due to multiple factors including the "Sell America" trade phenomenon, mounting U.S. debt concerns, and expectations of Federal Reserve interest rate cuts. After dropping approximately eight percent in 2025, the U.S. dollar has declined an additional one percent this year, providing artificial buoyancy to the Canadian currency.
CUSMA Review Presents Critical Tail Risk
The Canada-United States-Mexico Agreement review scheduled for this year represents what Baig describes as a "tail risk worth taking seriously" for investors with Canadian dollar exposure. While most economists expect the trade pact to survive the review process, the possibility exists that former President Donald Trump could walk away from the agreement entirely.
"Currency markets have short attention spans," observes Baig. "While traders are fixated on broad-based U.S. dollar weakness, the risk of a negative CUSMA review outcome has quietly faded into the background."
The current agreement provides Canada with crucial protection from the most severe U.S. tariffs, and its collapse would almost certainly push the Canadian economy into recession. Shirley Huang, senior analyst for global fixed income and currencies at RBC Global Asset Management, confirms that trade policy and CUSMA negotiations present "material risks" that could cause higher-than-average currency volatility during the first half of the year.
Market Complacency Evident in Options Pricing
Despite these significant risks, traders are not pricing in meaningful risk premiums for a no-deal outcome, according to Baig. This complacency manifests clearly in options markets where expectations of volatility in the USDCAD pair remain low, and the term structure appears flat. The market's positioning suggests minimal anticipation of disruption even as this major policy event approaches.
"The 'skew' continues to favor U.S. dollar puts, which means traders are betting against the U.S. dollar rather than seeking protection against a sharp depreciation in the Canadian dollar," explains Baig. He draws parallels to the 2016 Brexit vote when markets similarly underestimated well-flagged risks, resulting in the British pound sterling dropping ten percent in a single trading session following the unexpected Leave outcome.
Additional Factors Influencing Currency Movements
Several other developments have contributed to recent currency dynamics:
- Canadian pension funds likely increased their currency hedges in January as the U.S. dollar sold off and geopolitical concerns escalated
- Canadian equities have experienced significant inflows as investors rotate away from crowded U.S. technology stocks
- The cost to insure against adverse scenarios for the Canadian dollar remains relatively inexpensive, creating opportunity for prudent risk management
Baig emphasizes that markets have a notorious history of underpricing clearly identified tail risks, making the current complacency around CUSMA outcomes particularly concerning for those with Canadian dollar exposure. With protection currently affordable and risks substantial, strategists urge investors to consider the potential for significant currency volatility as the trade agreement review progresses.
