Synopsis: BofA forecasts a 'hawkish hold' stance in the upcoming Bank of Canada (BoC) policy meeting, with expectations of maintaining the overnight rate at 5.0% amidst economic frailties. While the bank acknowledges persistent inflation concerns that keep rate hike prospects alive, it foresees external factors, notably geopolitical risks and market sentiment, playing a more pronounced role in USD/CAD movements, potentially overshadowing monetary policy directives.

Key Takeaways:

• BoC's Hawkish Hold Strategy: Despite a sluggish economy, core inflation and wage growth concerns are expected to compel the BoC to adopt a 'hawkish hold' approach, keeping future rate hikes on the table. The central bank is anticipated to slash its GDP growth projections, acknowledging a quicker output gap closure since July.

• Inflation Worries Remain Central: Persistent inflationary pressures and robust wage growth continue to be central to the BoC's policy dilemma, ensuring that the bank remains vigilant and open to further tightening measures despite prevailing economic vulnerabilities.

• Monetary Policy Takes a Backseat in FX Dynamics: BofA posits that USD/CAD performance may be more susceptible to geopolitical tensions and market valuations in the near term than to Canadian monetary policy shifts. The currency pair, trading significantly above its perceived fair value, could realign in a risk-on market scenario or diverge further amidst geopolitical upheavals.

• External Shocks Over Internal Policy: The CAD's trajectory against the USD could be influenced more by external market shocks than domestic monetary policies. An unanticipated oil supply shock, traditionally not a CAD booster, coupled with deteriorating global risk sentiment, could prompt a sharp USD/CAD uptick, despite current overvaluations.

• Foreseeing Policy Shifts in 2024: BofA anticipates the initiation of a rate-cutting cycle by the BoC in June 2024, slightly later than their previous estimate of April 2024, given the sustained inflation concerns despite economic underperformance.

Conclusion: BofA's analysis underscores a period of precarious balancing for the BoC, juggling between inflation anxieties and economic fragility. While the imminent policy meeting is expected to maintain status quo rates, the door remains ajar for future hikes, reflecting the central bank's cautious optimism. For traders, the emphasis shifts to global market conditions and geopolitical events as primary drivers of USD/CAD trends, necessitating a broader perspective beyond domestic economic indicators and policy decisions. The potential for external shocks introduces an element of unpredictability, highlighting the need for market participants to stay agile and responsive to global developments.