The political landscape in Canada is currently shaking as Prime Minister Justin Trudeau’s government faces an intense crisis following the shocking resignation of its finance ministerThis turmoil has had immediate effects on the Canadian dollar, which recently plummeted to its lowest level since March 2020.

On Tuesday, the Canadian dollar continued its downward trajectory, experiencing a 0.5% decline, slipping below the crucial benchmark of 1 USD to 1.43 CADThis marks the lowest exchange rate seen since the onset of COVID-19, when cities were first shut down to curtail the spread of the virusEconomists point to the underlying weakness in Canada’s economy, which appears to be lagging behind that of its southern neighbor, the United StatesConcerns are mounting as officials in Canada struggle to devise strategies to counteract the looming threat of U.S

tariffs.

Skye Montgomery-Koning, a foreign exchange strategist at Barclays, noted that the recent political upheaval signals even more trouble ahead for the Canadian dollarShe emphasized that the economic performance of Canada is not keeping pace with that of the United States, compounded by the imminent threat of tariffs“We believe that the Canadian dollar will continue to face pressure in the coming days,” she stated, highlighting the precarious situation.

The resignation of Chrystia Freeland, a former journalist and Canada’s finance minister since 2020, adds to the unease surrounding the governmentIn her resignation letter, Freeland expressed her opposition to Trudeau’s push for increased short-term spending, particularly regarding tax cuts that would widen the budget deficitShe was chosen to spearhead a cabinet task force aimed at formulating a strategy to address U.S

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policy.

Heightening tensions, the U.Shas threatened to impose a hefty 25% tariff on Canadian goodsAccording to Michael Poonpedal, a strategist at Deutsche Bank, the recent political uncertainty makes it increasingly likely that such tariffs will be enacted“The bottom line is this: unless there is more stability in Canada’s political leadership, we believe that the U.Swill maintain its extreme position in trade with one of its largest partners,” Poonpedal conveyed in a report to clients on Tuesday.

Further complicating matters, Canada’s central bank has lowered borrowing costs, which in turn increases market expectations that the interest rate differential between Canada and the United States will widenEarlier on Tuesday, Canada’s inflation rate fell below the central bank's target for the second time in three months, providing a rationale for policymakers to consider significant interest rate cuts.

Jim Caron, the Chief Investment Officer for Multi-Asset Solutions at Morgan Stanley Investment Management, remarked in an interview, “The Canadian economy is currently on thin ice, and the political turmoil is exacerbating the situation.” He pointed out that the increasing geopolitical risks, in addition to the widening interest rate gap between Canada and the U.S., have placed additional strain on the Canadian dollar.

As a result of escalated political risks, implied volatility of the Canadian dollar surged to its highest level in over a year on Tuesday

This spike indicates that market participants are significantly wary of potential fluctuations in the currency, likely influenced by ongoing uncertainties.

Brad Bechtel, global head of foreign exchange at Jefferies, offered keen insights into the currency market’s movementsHe highlighted the impact of “holiday liquidity”—the reduced trading volumes often experienced during festive seasonsThis is likely to push the Canadian dollar onto a rocky path of sustained depreciation in the coming weeks, with potential exchange rates plummeting as low as 1 USD to 1.4668 CAD, a level not seen since March 19, 2020. “The outlook for the Canadian dollar has become increasingly grim,” he noted.

Examining the performance of the Canadian dollar against the U.Sdollar throughout the year illustrates a dire situationThe currency has been on a consistent downward spiral, with declines surpassing 7%. If this trend continues, the Canadian dollar may find itself mired in difficulties, facing the bleak prospect of its worst year since 2018. Recent data from the Commodity Futures Trading Commission serves as a warning bell—sophisticated hedge funds have ramped up their short positions against the Canadian dollar, capitalizing on the growing perception of its decline.

Kit Juckes, head of foreign exchange strategy at Société Générale, commented in a report on Tuesday that the Canadian dollar is "being mercilessly carved up." Juckes noted that the Bank of Canada has relinquished any rate support, while uncertainties surrounding tariffs further aggravate the situation, as the government struggles to maintain unity amidst rising dissent.