BOC Tilts, USD Downside Potential

The Bank of Canada took a surprisingly cautious tone in comments that undercut the loonie on Wednesday. The kiwi was the top performer while cable lagged after Carney reiterated the potential for further moves. Comments from Williams and the Beige Book underscore the unlikelihood of a Fed cut. A new EUR trade has been issued ahead of Thursday's ECB meeting.

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The BOC left rates at 0.50%, as entirely expected but also highlighted downside risks. They essentially said that growth was slower in H1 than they expected and it's looking like H2 might miss as well but they're going to wait and see.

USD/CAD had been at a session low of 1.2823 before the release and jumped to 1.2912 afterwards. It later trimmed some of the gains when the API energy inventory report showed a massive drawdown.

The market had been pricing just a 13% chance of a BOC cut around year-end. That's likely to rise and CAD to decline, especially if incoming data gives Poloz more cause for concern.

In the US, the Fed's Williams had the opportunity to push back against low rate hike odds but he stuck to a similar script, stopping at saying anything more than that Sept is a 'live' meeting. The Beige Book was also an opportunity to highlight economic optimism but, if anything, it was downcast on the economy and said overall inflation pressures were 'slight'.

At best, the Fed can argue that it may hike to trim financial risks because the case for inflation just isn't there. If economic data continues to muddle along, the case won't materialize at all and that raises the question about how far the dollar could fall.

Lately, the broad dollar slide offers some insight into the risks. Since July 26, what was a relatively upbeat/hawkish period for the dollar, it's been the worst G10 performer.  NZD/USD is up nearly 7% since that time. On rate differential alone (nevermind crowded USD positions) the euro could rise five cents.

Looking ahead, the final reading on Q2 Japanese GDP is expected to be unrevised at 0.0% q/q. The larger market impact will likely be from July Australian trade balance, which is expected to show a deficit of AUD 2.7B. More than the spread, the absolute reading on exports may drive the Aussie reaction.