USD/CAD's upside recovery could be limited on central-bank divergences

• USD/CAD finds traction on turn-around Tuesday.
• USD/CAD could find the top side a struggle when markets get back to the BoC/Fed trade.

USD/CAD has picked up a bid as U.S. yields stabilise and the dollar firms. However, it seems somewhat out of whack. The play on the pair has been related to the central bank divergence between the Federal Reserve and the Bank of Canada.

The blow-out in markets has had a dire effect on the commodity-complex which knocked the wind out of the Loonie - most notably in EUR/CAD as the EM-FX unwound that was following a major spike to the downside in CNH after the People's Bank of China set the CNY fix above 6.90, with the Chinese blaming US trade tariffs for the depreciation in the nation's currency, took a hold and made EUR go bid. 

Turn-around Tuesday does no favours for the Loonie

There has been some relief in markets over the past twenty-hours, (but not for the loonie), with the Chinese stating that they will not allow their currency to depreciate and Kudlow has announced that the US and Chinese negotiators are expected to get together again in September for further talks.

We have seen some stability back in US benchmarks, but these are relatively shallow compared to the downside declines as markets see risk so much more vulnerability to come due to the strain over global trade and central bank stimulus tools already exhausted - This brings us to the price of oil, for which the Loonie is closely correlated to.

The path of least resistance for oil would be to the downside under such circumstances, however, the supply-side narrative continues to remain supportive. OPEC production continues to undershoot and, perhaps somewhat lost in all of the trade tensions, Iran remains a factor as well. Should oil find some upside traction again, and with a combination of a steadfast sentiment from the BoC, (especially in light of last night's RBA), in any significant deterioration in US data, funds would be expected to struggle on the upside much past recent ranges and a downside adjustment would make sense. 

Analysts at TD Securities have called out the Loonie as an attractive bid given its carry staus and in a EM-FX market drenched in downside risks associated with global trade deterioration sentiment, then the Loonie's carry also makes sense. 

"CAD is likely to fare better on the crosses as its carry status is second to the USD in the G10. The latter underpins our expectation for USDCAD to drift towards 1.28 over the balance of the year,"

analysts at TD Securities argued.  

USD/CAD levels

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