Canadian Dollar: Goldman Sachs Look for "Tactical Upside" on BoC Hawkishness

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The Bank of Canada forms the highlight of a busy week for domestic drivers of the Canadian Dollar and strategists at Goldman Sachs are positioning for tactical upside in the currency on a 'hawkish' outcome.

The Wall Street bank reckons there is enough evidence of elevated inflationary dynamics in the economy to push the Bank of Canada (BoC) into another rate hike by October, an outcome that would prove supportive of CAD given the market's current expectations.

"Despite a soft Q2 GDP report, risks of a BoC hike next week look somewhat elevated," says Kamakshya Trivedi at Goldman Sachs. "Since the last meeting, inflation in the BoC's preferred core measures has shown little evidence of slowing."

"The Bank has expressed a need to see progress on inflation, and while the recent labour market cooling should reduce upward pressure on prices, additional tightening seems necessary to get to target," he adds.

The BoC's decision falls on Wednesday and market pricing shows investors widely expect rates to be kept on hold at 5.0%.

Other risks to CAD action this week include Governor Macklem's economic progress report on Thursday and labour data on Friday.

Goldman Sachs acknowledges arguments against a 'hawkish' BoC including Canada's labour market, which continues to cool, as does the economy as evidenced by last Friday's GDP report that revealed GDP retreated 0.2% in the month to June.

The data underscores why the market is poised for the BoC to leave rates on hold; "softer economic growth numbers suggest headwinds from earlier interest rate hikes are gaining strength," says Elsa Lignos, Global Head of FX Strategy at RBC Capital Markets. "We think there is more than enough evidence of cooling for the BoC to hold rates steady for now."

But Goldman Sachs thinks "more is needed... the bar to pause is now higher."

Goldman Sachs' strategists think there is an attractive risk-reward to being tactically short the Euro against the Canadian Dollar heading into the BoC.

This is because the CAD looks set to benefit from "a better US growth outlook, particularly versus EUR where the incoming growth data have remained weak.

This trade would benefit from "a more hawkish BoC if we are right that another hike is warranted by the October meeting," says Trivedi.