Last week, Citi announced a significant shift in its stance on the U.S. dollar, moving from a bullish position to a neutral one.
The change in view was prompted by an anticipated pullback of the USD, which aligned with the bank's expectations. The adjustment aimed to address what Citi considered an overvaluation of the currency, attributed to a "tariff premium."
Citi's latest Dollar Index (DXY) fair value model revealed a minimal residual overvaluation of just +0.1%, a stark decrease from the previous high of +3.4%. This valuation adjustment has occurred alongside a general weakening of the USD, especially against European currencies, and a reduction in the tariff risk premium.
The latter has seen a significant retracement of approximately 60% since election night, despite the recent imposition of short-lived tariffs on Colombia and discussions of potential tariffs on Canada and Mexico by February 1.
The bank's analysts noted that the situation with Colombia underscores President Trump's focus on immigration, suggesting a prioritization of negotiations with Mexico and Canada, which could potentially lead to the Canadian dollar's underperformance.
However, the USD/CAD exchange rate has remained relatively stable, fluctuating within the 1.43 to 1.45 range. Citi acknowledged the possibility of the rate moving to 1.47 if it breaches the 1.45 level, although they remain skeptical about the implementation of 25% tariffs.
Citi's analysis suggests that the tariff threats may serve more as a negotiation tactic to advance discussions on immigration and the U.S.-Mexico-Canada Agreement (USMCA).
The bank posited that if February 1 passes without the imposition of new tariffs, the USD could experience another, possibly final, dip before finding stability at a higher range.
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