Goldman, Morgan Stanley at Odds Over Loonie's Outlook Before BOC

(Bloomberg) -- Two of Wall Street’s biggest banks predict dramatically different paths for Canada’s currency over the coming months.

Strategists at Goldman Sachs Group Inc. are telling clients the loonie will strengthen to C$1.18 against the dollar over the next year as Canadian inflation firms and the greenback’s rally fades. Just two weeks ago in its mid-year outlook, Morgan Stanley took the other side of the trade, saying that a reliance on foreign funding to finance the nation’s current account deficit and a dovish central bank should see the pair return to C$1.34 in a year.

Goldman, Morgan Stanley at Odds Over Loonie's Outlook Before BOC

The standoff comes as Bank of Canada policy makers meet seeking to balance concerns over household indebtedness and the future of the North American Free Trade Agreement with signs of a strengthening economy. Markets don’t expect officials to raise rates at Wednesday’s announcement. But traders are looking for indications that Governor Stephen Poloz is ready to resume tightening in the coming months, and are trying to gauge whether he’s inclined to match the Federal Reserve’s trajectory on rates.

“Fading growth headwinds, limited spare capacity and on-target inflation, a sharp improvement in Canada’s terms of trade, and the currency is undervalued and investors are generally positioned short” -- all suggest the Canadian dollar will outperform, Goldman’s Zach Pandl and Karen Reichgott wrote in a May 25 note.

The loonie traded at C$1.3010 per dollar as of about 9:15 a.m. in Toronto. It was the worst-performing Group-of-10 currency in the first quarter. Yet it’s benefited from surging crude prices in recent months to hold firm against the greenback even as its G-10 peers have slumped.

Dueling Views

Goldman expects that stronger-than-forecast first quarter growth and rising inflationary pressures will spur the BOC to resume hiking, after policy makers tapped the brakes following three rate increases in five meetings through January. The next hike will come at the bank’s July meeting, Goldman predicts. Traders are pricing in about a 55 percent chance of a hike by then, according to overnight index swap pricing.

Morgan Stanley, meanwhile, expects Poloz to keep policy dovish and allow Canada’s economy to “run hot” to boost growth and inflation. The nation’s sensitivity to declining global liquidity and risk sentiment because of dependence on portfolio inflows to fund its current account deficit will also undermine the loonie, strategists led by Hans Redeker wrote in the firm’s global FX mid-year outlook this month.

“The BOC is hoping to boost nominal incomes faster than debt-service costs, enabling households to eat away at their debt burdens without the painful process of consumer retrenchment,” the strategists wrote. “These policies also have a negative impact for the currency, though.”

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