The focal point in recent days has been the imposition of tariffs on Canadian exports to the United States, said UBS.

The 25% universal tariff rate proposed initially didn't come into effect, but the level of uncertainty remains high, wrote the bank in a note to clients. Any such measure would also have significant stagflationary consequences for the U.S., making it a costly strategy for the U.S. administration, as was the case following the steel and aluminum tariffs in
Trump 1.0.

Canadian retaliatory measures to the new steel and aluminum tariffs weren't to be announced at the time of UBS writing its note but will likely be in kind.

Canada remains in a weak negotiation spot politically, with new elections likely to happen in late Q2, stated the bank. In addition, the economy is hurting given its high rates sensitivity and elevated Bank of Canada (BoC) policy rates for some time.

Accordingly, the BoC announced another rate cut on Wednesday and again noted its readiness to react to any economic shock in relation to U.S. tariffs. While this offers some respite for the Canadian economy, it hurts the Canadian dollar's (CAD or loonie) carry prospects, pointed out UBS.

Even though CAD has underperformed peers year-to-date, the bank argued that USDCAD has long been complacent about tariff-related risks. However, in recent days, the exchange rate exhibited a higher sensitivity concerning this topic.

While UBS agrees with the market's stance that a major escalation will be too costly -- even for the Trump
Administration -- the bank also doesn't believe that the end-game is a blue-sky scenario without tariffs or other costs for Canada to bear altogether.

So, UBS thinks a larger risk premium in USDCAD spot would be warranted and revised its short-term forecasts upward to 1.46 for June. In line with this, downside-volatility-selling strategies remain worthwhile over this horizon.

In the second half of the year, however, the bank believes USDCAD will trade lower -- in tandem with broader US dollar (USD) weakness -- to end the year at 1.42.