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Monday, Jun 12, 2017

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U.S. Review

Calm Before the Storm

• It was a quiet data week in the United States before a slew of economic data and events next week, including a highly anticipated Federal Open Market Committee meeting.
• Job openings reached an all-time high for the series, but hiring and quits dipped, highlighting the structural challenges that remain in the labor market.
• Factory orders for April fell slightly, while the ISM nonmanufacturing survey signaled continued solid expansion in the service sector.

Calm Before the Storm

The economic data released in the United States this week were fairly light, with a full slate for next week. The most striking piece of data from this past week was the surge in job openings in April. Openings rose a sizable 259,000, surpassing 6.0 million in total and marking a new all-time high for the series (see chart on front page). This is an encouraging development, as the labor market continues to create jobs at a remarkably steady clip. Openings growth was generally broad-based, with gains in the private and public sectors. The few weak spots were concentrated in durable goods manufacturing and retail trade.

Despite the surge in new openings, hiring actually dipped in the month. As illustrated in the top chart, the job opening rate has risen dramatically since 2014, but the hiring rate has largely remained steady. The stagnation in hiring and the rising number of job openings suggest structural challenges beneath the cyclically improving labor market. A skills mismatch, uneven job opportunities by geographic region and other factors are weighing on the economy. This dichotomy between cyclical improvement and structural headwinds help explain many of the mixed signals present in today's labor market. One encouraging development is the location of recent job opening growth: openings are up 25 percent in the Northeast and 7 percent in the Midwest, two regions that have seen relatively slower growth this expansion, outpacing the faster-growing regions of the West and South.

The ISM non-manufacturing index dipped slightly in May to 56.9 (any reading above 50 indicates expansion). The business activity and new orders components declined, but the backlog of orders component reached a cycle-high of 57.0. The survey also showed a jump in employment, although this runs somewhat counter to the May jobs report, which saw private services hiring soften for many sectors. The ISM indices have moderated slightly from their post-election spikes, but both of them remain firmly in expansion territory and above the levels that prevailed in 2016. This signals that, although economic growth in 2017 will likely fall short of the three percent plus pace some market participants hoped for in the wake of the election, growth should improve from 2016's sub two-percent rate.

In the factory sector, the slow growth narrative for manufacturing and business spending remained intact. Factory orders fell 0.2 percent in April, but upward revisions to the March reading helped offset the decline. Core capital goods orders were modestly revised up from the March reading. As the bottom chart shows, core capital goods orders have clearly improved after a steep slide that began around when oil prices took a nose dive. After a few months of slow growth, however, core orders are growing at just a 3.8 percent three-month average annualized rate. Still, the main takeaway is that, modest as the core capital goods figures might be, they suggest that equipment spending had at least some positive momentum heading into Q2. We expect total real business fixed investment to increase at a 5.5 percent annualized rate in Q2.

U.S. Outlook

CPI • Tuesday

The Consumer Price Index (CPI) rose 0.2 percent in April, partially recouping the prior month's 0.3 percent loss. Energy prices, which tend to be a significant factor in the monthly headline performance, rose 1.1 percent on the month. The core CPI inflation environment remains soft, however. Core consumer prices rose a modest 0.1 percent in April, while the annual core inflation rate slipped below 2 percent for the first time since October 2015. The three-month annualized rate of core CPI has also fallen from its recent high, pointing toward further moderation in the year-overyear rate in the coming months.

We expect the CPI to be unchanged in May, with the year-over-year decreasing to 1.9 percent. While the CPI has been weaker than our initial expectations, our overall economic growth outlook remains in place, and we do not think the recent soft inflation prints will deter Fed officials from raising rates at the June meeting.

Previous: 2.2% (Year-over-Year) Wells Fargo: 2.0% Consensus: 2.0%

Retail Sales • Wednesday

Retail sales rose a less-than-expected 0.4 percent in April, while March's initially reported decline was upwardly revised to a 0.1 percent gain. The headline increase was supported by rebounds in auto sales and sales at building material & garden equipment stores, which rose 0.7 percent and 1.2 percent, respectively. Nonstore retailers, which continue to benefit from the structural shift towards online purchases, also reported a strong gain. Control group retail sales rose a more modest 0.2 percent in April, although the February and March prints were revised higher.

While April's increase in retail sales was weaker than expected, the details point to a potential acceleration of consumption in Q2. We expect retail sales to rise a modest 0.2 percent in May and look for personal consumption to increase at a 3.3 percent annualized rate in Q2.

Previous: 0.4% Wells Fargo: 0.2% Consensus: 0.1%

Housing Starts • Friday

Housing starts fell 2.6 percent to an annualized rate of 1.172 million units in April, disappointing consensus expectations for a modest gain. A 9.2 percent drop in multifamily starts accounted for the headline's entire decline, while single-family starts inched up 0.4 percent. We expect multifamily construction to continue to slow amid lessening demand and the onslaught of apartment completions that have inundated the market in recent years.

Despite the disappointing print, housing starts for the first four months of the year are running 5.3 percent ahead of their yearago level and single-family starts are up 7.0 percent. The upward trend in single-family starts is consistent with strong readings for homebuilder confidence. We expect residential construction activity to bounce back in May, and look for the pace of housing starts to rise to a 1.207 million annualized rate.

Previous: 1.172 million Wells Fargo: 1.207 million Consensus: 1.223 million

Global Review

Eurozone on Solid Footing in Q2

• The economic expansion that is underway in the Eurozone remains intact. The ECB said this week that the risks to the economic outlook "are now broadly balanced." That said, we believe that the ECB is still a long way from hiking policy rates.

U.K. Elections: Now What?

• Prime Minister May lost her gamble to increase the Tories' parliamentary majority in Thursday's snap election. A period of political uncertainty now settles in the United Kingdom. We expect that British economic growth will remain sluggish over the next few quarters.

Eurozone on Solid Footing in Q2

Data released this week showed that real GDP in the euro area, which originally was reported to have grown 0.5 percent (2.0 percent at an annualized rate), actually grew 0.6 percent (2.3 percent annualized) in Q1 2017 (see graph on front page). The revised data lifted the year-over-year growth rate from 1.7 percent to 1.9 percent. Moreover, the breakdown of the GDP data into its underlying demand components showed that the outturn was "good" in the sense that real GDP growth was driven entirely by growth in domestic demand.

Economic activity in the Eurozone appears to be expanding at a solid pace in the current quarter as well. Although factory orders in Germany fell 2.1 percent in April relative to the previous month, they remain up 3.5 percent on a year-ago basis (top chart). German industrial production (IP) rose 0.8 percent in April, which was stronger than expected, and March's IP outturn was revised higher. French IP dipped 0.5 percent in April, only partially reversing the 2.2 percent surge registered in March. In general, we expect that the modest pace of expansion that is underway in the Eurozone will continue for the foreseeable future. See the "Interest Rate Watch" on page 5 where we discuss the implications of recent economic data in the Eurozone for ECB monetary policy.

U.K. Elections: Now What?

In the United Kingdom, Prime Minister May's gamble to increase her parliamentary majority failed in Thursday's snap election. The final tallies are not yet complete, but as of this writing it appears that the Conservative Party will fall about 8 seats short of the 326 seats needed to form an absolute majority in the House of Commons. The British pound, which fell sharply in the wake of the Brexit referendum last year, weakened against the U.S. dollar in the immediate aftermath of the election (middle chart).

The surprise election results—most observers expected that the Tories would pick up even more seats when May called the snap election on April 18—will introduce even more uncertainty into British politics. The first task will be to form a new government. The Conservative Party will need to decide whether to govern with a coalition partner or to attempt to form a "minority" government. May's future as the leader of the Conservative Party, and hence, as the prime minister, is far from assured. Britain's hand in the upcoming Brexit negotiations with the European Union undoubtedly has been weakened by the election results.

After growing at an annualized rate of 2.3 percent in the second half of 2016, U.K. real GDP growth slipped to 1.2 percent on a sequential basis in Q1. Incoming data suggest that growth remains lackluster in the current quarter. Although British IP edged up 0.2 percent in April, it was not enough to offset the 0.5 percent contraction registered in March. On a year-ago basis, IP was down 0.8 percent in April (bottom chart). Although the election's outcome is probably not enough to push the U.K. economy into recession, we expect that real GDP growth will remain sluggish over the next few quarters.

Global Outlook

Chinese Industrial Production • Tuesday

China's industrial production (IP) undershot market expectations rising just 6.5 percent year over year in April—dropping from March's 7.6 percent pace. The slowdown in production was due to softness in overseas demand and domestic consumption. Electricity production slowed markedly over the month signaling that much of the weakness in IP was concentrated in manufacturing output. However, the production of steel, glass and cement fared better. For May, the consensus expects overall IP growth to slow further to 6.4 percent year over year.

Next week, retail sales and fixed asset investment are also slated for release. Retail sales growth cooled in April, as muted domestic demand constrained sales. Fixed investment growth remains a shadow of its former self. The recent weakness of all three figures suggests that economic growth more than likely slowed in Q2.

Previous: 6.5% Consensus: 6.4% (Year-over-Year)

U.K. Bank of England Rate • Thursday

The Bank of England (BoE) held rates for another month in May, voting 7-1 to leave its main policy rate steady at 0.25 percent, despite rising inflation in the United Kingdom. Yesterday, voters hit the polls for an early general election. Prime Minister May lost the Conservative parliamentary majority that she was hoping to keep, creating political uncertainty as the country begins to negotiate its Brexit terms. That said, we believe that it is highly unlikely that the BoE will change its monetary policy in the near term and expect for the bank to hold rates at 0.25 percent next week.

Other data on the docket for next week include retail sales, and producer and consumer price inflation. Consumer inflation has been running ahead of the BoE's 2 percent target for the past three months and currently sits at 2.7 percent year over year. The bank also upwardly revised its inflation forecast to 2.8 percent this year from its previous forecast of 2.4 percent.

Previous: 0.25% Wells Fargo: 0.25% Consensus: 0.25%

Australia Employment • Friday

Recently released data this week showed that the Australian economy expanded at a 1.7 percent annualized pace in Q1. Even with slower growth, the labor market added 37,400 jobs in April. Part-time employment accounted for all of the employment gains on the month, rising 49,000, more than offsetting the 11,000 decline in full-time employment. The participation rate held steady at 64.8 percent as the jobless rate fell two tenths of a percentage point to 5.7 percent—nearing a low not seen since 2013. Though, employment growth has been strong, wage growth, on the other hand, has been more stagnant.

That said, the forward momentum of the labor market also allowed the Reserve Bank of Australia to hold rates unchanged at 1.50 percent at its latest meeting. For May, markets look for the economy to have added 10,000 jobs.

Previous: +37,400 Consensus: +10,000

Point of View

Interest Rate Watch

ECB on Hold for Now

The European Central Bank (ECB) held a widely anticipated policy meeting this week. As expected, the Governing Council decided to keep its three main policy rates unchanged at the levels that have been maintained for more than a year (top chart). Furthermore, the Governing Council did not make any changes to its pace of bond buying, which currently totals €60 billion per month (middle chart). There was some speculation that the ECB may signal a further tapering in its quantitative easing (QE) program, but the Governing Council continued to say that it would buy €60 billion per month through the end of the year.

The Governing Council made one notable change to its policy statement. It had been characterizing the risks to the economic outlook as largely skewed toward the downside. However, the ECB upgraded its assessment and now says that the risks "are now broadly balanced." As discussed on page 4, the economic expansion that is underway in the euro area appears to be increasingly self-sustaining, hence the upgrade to the risk assessment.

The extraordinary amount of ECB policy accommodation has driven short-term interbank rates in the Eurozone into negative territory (bottom chart). Consequently, interest rates at which consumers and businesses borrow have also drifted lower. In our view, the policy accommodation that has been supplied by the ECB has contributed, at least at the margin, to the economic upswing that is currently underway in the Eurozone.

Looking forward, we believe that the Governing Council will announce further QE tapering steps this autumn and that the ECB will cease buying bonds in the first half of 2018. A rate hike seems even further afield. The statement released on Thursday acknowledged that "measures of underlying inflation continue to remain subdued." Until the core rate of CPI inflation begins to trend toward 2 percent in an unmistakable fashion, the Governing Council likely will keep rates unchanged. We do not think that the ECB will hike rates until late 2018, at the earliest.

Credit Market Insights

Consumer Credit Slows in April

Consumer credit rose just $8.2 billion in April, the slowest pace since mid-2011. Nonrevolving and revolving credit growth were soft in the month, rising 2.9 percent and 1.8 percent, respectively. Growth in revolving and non-revolving credit has stabilized at around 6 percent on a year-over-year basis, a trend that has held since early 2016. This convergence makes sense as student and auto lending cool, while revolving credit plays catch-up after an unusually slow recovery.

Over the past couple years total consumer credit growth has slowed. Relative to disposable income, however, consumer credit remains elevated. At 26.5 percent of disposable income, consumer credit now represents a larger share of disposable income than it ever has since the series began in 1960.

Also at an elevated level is the percentage of nonrevolving consumer credit held by the government and Sallie Mae (the former government entity that now offers private education loans). The share now stands at 38.7 percent compared to just 10 percent in 2010. As students continue to take out loans to finance schooling and the price of education continues to climb, this share is likely only to grow. As the Federal Reserve continues on its rate tightening schedule, it will be interesting to observe the response of consumers in the credit market. Chargeoff rates saw a spike in the final quarter of 2016 – will this continue?

Topic of the Week

Household Net Worth Hits All-Time High

Household net worth soared in Q1 on the back of rising home and equity prices. Aggregate household net worth in the United States now stands just shy of $95 trillion. On an inflation-adjusted, per capita basis, household net worth was about $261,000, well surpassing the prerecession peak (top chart).

A strengthening housing market has helped homeowners on the asset side of the balance sheet. The national CoreLogic Home Price Index was up 6.9 percent on a year-ago basis in April, up from 5.5 percent as recently as January. Lean inventories and a gradual shift in the demographic fundamentals have helped spur prices higher and promote a sellers' market. Equity markets also helped drive net worth higher: the S&P 500 rose 5.5 percent over the quarter.

On the debt side of the balance sheet, liability growth continues to pick up relative to the historically slow pace seen earlier in the expansion (bottom chart). The composition of household borrowing growth has shifted over the course of the expansion. Rapid growth in student and auto loans early in the expansion has begun to moderate, while mortgage debt and revolving credit have turned from outright contraction to steady growth.

The rise in net worth in Q1 corresponds with the continued strength in consumer confidence seen during the quarter. Yet, real consumer spending growth was a paltry 0.6 percent in Q1. It appears rising confidence and the wealth effect are being offset by other factors that drive consumer spending, such as slowing job growth and wages that have persistently failed to accelerate. Another factor to consider is that this data from the Federal Reserve is aggregate data that tells us little about the distribution of gains. If households that are seeing the bulk of the gains have a lower marginal propensity to consume, we might not see as much of a bump in short-term economic growth. We expect a rebound to 2.5-3.o percent real growth in personal consumption the rest of the year.

What Happens When Your Gamble Doesn't Pay Off?

On April 8, British Prime Minister Theresa May announced that she was calling a snap parliamentary election to be held on Thursday, June 8. At the time, the Conservative Party was riding high in the polls and Jeremy Corbyn, the leader of the Labour Party, was not seen by many as a very effective leader. May had hoped to increase her parliamentary majority - the Tories held 330 seats in the 650 seat House of Commons - which she reasoned would increase her bargaining strength heading into the upcoming Brexit negotiations with the European Union (EU).

May's gamble has failed spectacularly as the Conservative Party appears to have won only 318 seats in yesterday's election, which means it is 8 seats short of an absolute majority. So what happens now? The Conservatives will try to form a new government. One option is to seek out a coalition partner or partners that would produce a majority in parliament. In a statement after the election, May indicated her plans to form a coalition government with the Democratic Unionist Party (DUP). Under this arrangement the DUP, or any other minority member of the coalition, may get a few seats in the cabinet. Another option would be a "confidence-and-supply" deal. Under this arrangement there would be no formal coalition, but one or more parties might agree to support the Conservatives on major pieces of legislation such as the budget. By its very nature, however, such an arrangement tends to be unstable. If the Tories cannot find a coalition partner and no parties are willing to work with it on a "confidence-and-supply" arrangement, then the Labour Party would be given a turn to try to form the next government.

Theresa May's future as the prime minister of the United Kingdom is tenuous. Even if the Tories stay in power, May's failed gamble has weakened her position as the leader of the Conservative Party. Some of her rivals in the Conservative Party could challenge her for party leadership in coming weeks. In addition, Britain's bargaining position in the upcoming Brexit negotiations visà- vis the EU has been weakened. Some policymakers in EU countries could view the election results as an indication that British voters are starting to regret their decision in last year's Brexit referendum to leave the EU.

Does Political Uncertainty Have Economic & Financial Consequences?

As implied above, the United Kingdom now faces a period of political uncertainty. Not only has the election produced some political precariousness, but it has also raised the uncertainty that is inherent in the upcoming Brexit negotiations. Speaking of Brexit, some analysts thought last summer that the uncertainty associated with Brexit could lead to a mild U.K. recession in late 2016/early 2017. In any event, real GDP growth in the United Kingdom held up well through the end of 2016 (Figure 1). However, real GDP grew only 0.3 percent (1.2 percent annualized) on a sequential basis in Q1-2017, and incoming monthly data suggest that the pace of economic activity thus far in the second quarter has remained slow. In our view, the election results are not likely to have meaningful effects on the British economy in the foreseeable future, and we are not inclined to make significant changes to our economic forecast at this time. In that regard, we forecast that real GDP growth in the United Kingdom will slip from 1.8 percent last year to 1.5 percent in 2017 before edging back up to 1.7 percent next year.

In terms of financial variables, the major fallout thus far appears to be largely confined to the exchange rate. Prices of British government bonds are little changed in the immediate aftermath of the election news, and the U.K. stock market appears to be unfazed. The British pound nosedived nearly 2 percent when the initial election results were released at 10:00 PM BST, and it remains on the ropes as of this writing. However, the reaction of sterling to the election news pales in comparison to the nosedive it suffered last summer in the immediate aftermath of the Brexit referendum. Indeed, the pound plummeted 8 percent on balance against the U.S. dollar on the day following last year's referendum.

Looking forward, we expect that sterling will depreciate mildly against the greenback over the next few quarters. That said, we forecast that the dollar will strengthen modestly vis-à-vis most currencies in the near term as the Federal Reserve continues to tighten policy while most other major central banks continue to maintain accommodative policy stances. In other words, the election has not really caused us to rethink our views regarding our forecast for the value of sterling against other major currencies.

After political uncertainty in the United Kingdom starts to dissipate, there is the chance that sterling depreciation could eventually be reversed. If the election results produce an outcome that reduces the probability of "hard" Brexit (i.e., the United Kingdom decides to give up full access to the EU single market in order to have more sovereignty over its trade and immigration policies) sterling could recover. Everything else equal "hard" Brexit would increase uncertainty because it would imply more adjustment of the British economy from the status quo. "Soft" Brexit, in which only modest changes to trade and immigration policies would be required, would imply less adjustment vis-à-vis the status quo. Stay tuned.

HIGHLIGHTS OF THE WEEK

United States

• International events overshadowed domestic developments this week. Data on job openings and the non-manufacturing sector confirmed last Friday's payroll report of slowing job growth, something that is to be expected at this point in the cycle.
• The ECB kept its monetary policy broadly unchanged, tilting its forward guidance slightly hawkish given the strong economic performance. However, downward revisions to its inflation forecasts suggests that the ECB is unlikely to join the Fed in tightening monetary policy anytime soon.
• The UK election has charged a shaky Conservative coalition government with negotiating Brexit. Although the election result serves to weaken the UK's negotiating hand, it increases the likelihood that the UK maintains ties with the EU, favoring an arrangement similar to that between Norway and the EU.

Canada

• It was a relatively busy week in Canadian markets, with the loonie stumbling on the oil price drop midweek, before regaining some poise on robust economic data.
• Employment surged in May, with the economy adding 54.5 thousand jobs during the month. The gains were quite broad and all in full-time positions. Wages and hours remained weak but improved from previous months.
• Housing data pointed to resilience across most Canadian markets and a welcome cool-off in new and existing activity in Ontario. The Bank of Canada's June FSR highlighted a growing concern about both household indebtedness and housing market imbalances, with a sharp correction in home prices in overheated markets flagged as a key risk for financial stability.

UNITED STATES - EUROPE ON THE MIND

Geopolitical events overshadowed domestic developments this week, although as typical of the new normal, financial markets remained relatively calm.

Following last Friday's payrolls report, there was little economic news to stir U.S. risk or fixed income markets ahead of next week's interest rate decision by the FOMC, in which it is widely expected to raise the federal funds rate by 25 bps. Both the job openings, turnover, and layoffs survey (JOLTS) for April and the ISM non-manufacturing survey for May were consistent with the message of slowing job growth from Friday's payrolls report. This shouldn't come as a surprise as employment growth tends to slow as the duration of an economic expansion lengthens.

Perhaps more insightful as to the health of the U.S. labor market are industry anecdotes and job openings data suggesting that the tight labor market is making it tougher for employers to find qualified help. Maybe this will provide the catalyst to ignite wage growth that has been subdued despite a tightening labor market, raising price pressures sufficiently for the FOMC to continue to normalize monetary policy with conviction.

Weak underlying inflation is a phenomenon that has been plaguing many advanced economies for the better part of the last decade, accented by overly optimistic forecasts from inflation-targeting central banks. At this week's monetary policy meeting, the ECB left interest rates and monthly asset purchases unchanged, but tilted its forward guidance slightly more hawkish, a nod to the more balanced risks around the outlook for inflation given the strong economic performance of the Euro Area. Nonetheless, downward revisions to their inflation forecasts were widely interpreted by markets as dovish. A capitulation by the ECB, perhaps, to the fact that despite a rapid absorption of economic slack, underlying price growth will remain subdued over the next few years in the absence of significant wage pressures.

The ECB is right to remain dovish given the downside risks to the Euro Area outlook. Aside from the threat posed by a possible election of the anti-EU/euro M5S in Italy, perhaps a bigger threat to the region's outlook is what may be a messy Brexit negotiation. Overnight we learned that the Conservative government's gamble to ensure a strong majority in the UK parliament for the next four years failed. Instead, it appears that a shaky Conservative coalition government will negotiate exit terms with the EU, a result that only serves to further weaken their negotiating position, while raising policy uncertainty for businesses. On the bright side, this outcome increases the likelihood that the UK will maintain some existing ties with the EU, favoring an arrangement similar to that between Norway and the EU.

Lastly, this Sunday is the first of two rounds of French parliamentary elections. President Macron's En Marche! party, supported by its Democratic Movement ally, is expected to earn a majority, giving the newly elected president a strong mandate to pursue a pro-business reform agenda aimed at improving the long-run growth performance of the French economy. The strength of his mandate will be known after the conclusion of next week's second round ballot, but it appears that this election should deal another strong blow to French populism for the time being.

CANADA - ECONOMIC STARS ALIGNING FOR EARLY-2018 RATE HIKE

It was a relatively busy week in Canadian markets as investors digested fresh labour and housing market data and got an updated view from the Bank of Canada on the stability of the financial system. Equities and the loonie stumbled mid-week on a slump in oil prices related to a growing U.S. supply glut. But, Canadian markets recovered on solid economic numbers that painted a relatively healthy picture of the Canadian economy, and boosted the prospects for an earlier Bank of Canada rate hike. Markets are now pricing a one-third chance of a hike by year-end, with the odds of a move in the first quarter of 2018 better than even.

The renewed enthusiasm for the Canadian economy was highlighted by the strong employment numbers this morning. The Labour Force Survey indicated that 54,500 jobs were created across the country in May, with 77,000 full-time jobs added on the month. The May tally takes the twelve-month tally to 317,000, its fastest pace more than four years. Workers also flocked back into the labour force, which expanded by nearly eighty-thousand after a sizeable decline in the month prior, pushing the jobless rate up a tick to 6.6% in May. While P.E.I. registered the largest relative gain (+1,500), and is now leading the country in job growth at 4.7% y/y, most of the absolute gains were to be had in British Columbia (+12k), Quebec (+15k) and Ontario (+20k). Encouragingly, the job gains were relatively broad based, with manufacturing and most private services showing gains, while finance and construction had another weak month (Chart 1).

Softer finance and construction job numbers are in line with the cooling housing market. The pace of housing starts in May slowed to 194,000 annualized, down 20 thousand on the month and its slowest level in six months. All the weakness was in Ontario, where starts pulled back by 20 thousand after a 16 thousand drop in April (Chart 2), as developers digest the impact of the Fair Housing Plan introduced by the province on April 20th. In a complete reversal of the first-quarter story, the existing home market is also cooling. TREB figures released early this week pointed to a surge in new listings and decline in sales in May. Average transaction price dropped in the month, but this was more of a compositional effect given the skew towards condos. On the other hand, the quality-adjusted index increased slightly on the month, but decelerated to 29% from 31.6% year-on-year.

As outlined in our recent paper, this is a welcome cooloff for the red-hot market. The Bank of Canada's updated Financial System Review highlighted growing concern about both household indebtedness and housing market imbalances, with a sharp correction in home prices in overheated markets flagged as a key risk for financial stability. Other key risks identified include a severe nationwide recession, a sharp increase in long term rates driven by higher global risk premiums, and stress emanating from emerging markets. These risks will remain top of mind for policy makers, but are unlikely to sway the Bank of Canada from proceeding with rate increases. All in all, while we don't expect the Bank to move this year, an early-2018 hike is an increasingly likely scenario provided that economic data remains upbeat.

UK, Switzerland, Japan and US central banks to deliver statements

The US dollar is mixed against majors in a week that saw geopolitical factors drive markets. The surprising result of the UK elections with conservatives being forced to partner to form a government has the pound depreciating across the board. Commodity currencies (AUD, CAD and NZD) appreciated versus the greenback and the majors (CHF, EUR and GBP) traded lower. The JPY ended the week flat against the dollar ahead of a busy week in central banking.

The U.S. Federal Reserve will host the Federal Open Market Committee (FOMC) meeting on June 13 and 14. It will release its monetary policy statement on Wednesday, June 14 at 2:00 pm EDT. The Fed is highly anticipated to hike rates by 25 basis points for the second time this year, to a 100–125 basis points for the Fed funds rate. The CME FedWatch tool is showing a probability of 95.8 percent of a higher rate on Thursday. Fed Chair Janet Yellen will take part in a press conference at 2:30 pm EDT to give more details on the central bank's decision.

The Swiss National Bank (SNB) will publish the Libor policy assessment and a will kick-off a press conference on Thursday, June 15 at 3:30 am EDT. In the aftermath of the UK elections the Bank of England (BoE) is unlikely to make a drastic change. The BoE will publish its monetary policy summary and minutes of its policy meeting on Thursday at 7:00 am. The conservative party called a snap election to further solidify its majority and instead it is now forced into a partnership with Northern Ireland's Democratic Unionist party to form a working majority. The Bank of England will have to wait until there is more clarity on Brexit before it can raise rates.

The Bank of Japan (BOJ) will round up the week on Friday, June 16 with its monetary policy statement being released at midnight and BOJ Governor Haruhiko Kuroda hosting a press conference at 2:30 am EDT.

The BOJ is in a similar position to the European Central Bank (ECB) as it could deliver an optimistic assessment on the Japanese economy, but being cautious about inflation losing traction. The market is not forecasting any change to the interest rate or stimulus program at this time.

The EUR/USD lost 0.749 percent in the last five days. The single currency is trading at 1.1193 after the ECB met expectations by keeping the interest rate and QE program unchanged. The central bank did remove the reference to rate cuts, and President Mari Draghi praised the momentum of the economy, while at the same time warning of weak inflation. The USD was able to shake off some of the impeachment cloud surrounding the Trump administration after the testimony of James Comes. There was nothing new that emerged during the proceedings as Comey stuck to his notes on his meetings with President Trump. The USD was lifted by lack of evidence, but will remain under pressure as this is only a small part of the investigation surrounding his team and unofficial contact with Russian agents.

Political risk drove the direction of the pair last week, but going forward the US will release key economic data as well as the expected rate hike from the Fed further appreciating the dollar against the euro. The Trump administration continues to pledge a tax reform and infrastructure spending policies but until they materialize the June rate hike might be the last one for the US central bank in 2017.

The French parlimentary elections are not expected to bring as many fireworks as the UK elections but are nevertheless important as the results will define the type of government Emmanuel Macron gets to lead. The first round of elections will take place on June 11, with a second round if needed on the 18. Macron is expected to gain a majority with his newly formed party thanks to new rules put in place in 2014 that forbids representatives to hold two offices (local and federal) at the same time with the vast majority chasing to retain their local positions and not run again on this parliamentary elections. If Macron party gets a majority it would spell the end of the two party system in France.

Oil lost 3.612 percent in the last week. The price of West Texas Intermediate is trading at $45.71 after the massive buildup on Wednesday on the US weekly crude inventories. The forecast had called for another drawdown and instead the shock rise in inventories in the same week as the rift between Qatar and major Arab states put downward pressure on crude prices. The Organization of the Petroleum Exporting Countries (OPEC) has stabilized prices since they announced their production agreement with major producers last year that was put into effect in January. Nearing the end of the original six month duration members have agreed to a 9 month extension. Their goal of price stability has been met, but a glut in energy products remains as producers not part of the deal like the United States, Canada and Brazil have increased production. The US in particular has gone from a net importer of crude to an exporter offsetting the efforts from OPEC.

Weekly inventories are released every Wednesday at 10:30 am EDT. Last week there was a buildup of 3.3 million barrels when a drawdown of 3.1 million was expected. Oil disruptions have been the only factor that have driven oil prices higher, but due to the nature of the disruptions they are not consistent. Case in point the current Nigerian pipeline leaks. Nigeria and Libya due to disruptions are exempt form the production cut, but as soon as those go away the OPEC will face further internal pressure as the oil glut will continue due to stagnant demand for energy around the globe.

The GBP/USD lost 1.212 percent in the last five days. The shocking results of the UK election caused anxiety as the solid majority achieved in 2015 (itself a shock at the time) was wasted by a poor campaign that made the decision of a snap election questionable and could end the career of Theresa May. The election was supposed to put the Conservative party in better footing to deal with the EU in Brexit negotiations. Now needed a partner for majority the Conservative party will be more fractured as it misjudged the intentions of the British people once again. In a curious development it is the less likely probability of a hard brexit (that would have been pushed with a solid Conservative win) that is keeping the GBP from falling further. The Tories will be now forced to seek a more compromised soft Brexit but the EU is now more than ever in the driver seat.

Up ahead the Bank of England (BoE) will be tasked with riding out the political uncertainty of a Brexit outcome that is a moving target. The central bank is not expected to make any major interventions like it did when the Brexit referendum results were announced.

Market events to watch this week:

Tuesday, June 13

• 4:30 am GBP CPI y/y
• 8:30 am USD PPI m/m
• 10:00 pm CNY Industrial Production y/y

Wednesday, June 14

• 4:30 am GBP Average Earnings Index 3m/y
• 8:30 am USD CPI m/m
• 8:30 am USD Core CPI m/m
• 8:30 am USD Core Retail Sales m/m
• 8:30 am USD Retail Sales m/m
• 10:30 am USD Crude Oil Inventories
• 2:00 pm USD FOMC Economic Projections
• 2:00 pm USD FOMC Statement
• 2:00 pm USD Federal Funds Rate
• 2:30 pm USD FOMC Press Conference
• 6:45 pm NZD GDP q/q
• 9:30 pm AUD Employment Change

Thursday, June 15

• 3:30 am CHF Libor Rate
• 3:30 am CHF SNB Monetary Policy Assessment
• 3:30 am CHF SNB Press Conference
• 4:30 am GBP Retail Sales m/m
• 7:00 am GBP MPC Official Bank Rate Votes
• GBP Monetary Policy Summary
• GBP Official Bank Rate
• 8:30 am USD Unemployment Claims
• Tentative JPY Monetary Policy Statement

Friday, June 16

• Tentative JPY BOJ Policy Rate
• 2:30 am JPY BOJ Press Conference
• 8:30 am CAD Core Retail Sales m/m
• 8:30 am USD Building Permits

*All times EDT

Next week's market movers

• In the US, the FOMC is almost certain to raise interest rates, according to market pricing. Thus, focus will probably be on what signals policymakers send regarding the pace of future hikes.
• The BoE is expected to remain on hold. Even though the market may pay some attention to this meeting, given the UK's political situation, monetary policy is likely to be overshadowed by political developments in the short term.
• The BoJ and the SNB are both anticipated to keep their policies unchanged as well.
• We also get key economic data from the UK, the US, China, Australia, and New Zealand.

On Monday, we have a relatively quiet day, with no major events or indicators due to be released.

On Tuesday, the UK CPI data for May will be released. The forecast is for both the headline and the core rates to have remained unchanged. We view the risks surrounding those forecasts as skewed to the downside, perhaps for a slight pullback, considering that the nation's services PMI for the month showed the weakest increase in prices charged by service-sector firms since November. In any case, we think that market focus on the day is likely to be on politics rather than economics. Tuesday will be the first day the new UK Parliament meets, and also the first deadline Theresa May will have to put together a deal for keeping herself in power. May will likely have to reach a deal with another party in order to achieve a majority in the House of Commons. If she fails to present such a plan, then the focus turns to the 19th of June. On that day, Parliament will vote on the Queen's speech, a list of the laws the government hopes to get approved over the coming year. If Parliament rejects the Queen's speech, then Labour leader Jeremy Corbyn could be invited to form a government.

On Wednesday, in the US, all eyes will be on the much-awaited FOMC policy announcement. This will be one of the "bigger" meetings, meaning that besides the rate decision we will also get fresh economic forecasts for the US economy, an updated "dot plot", as well as a press conference by Chair Yellen. The forecast is for the Committee to raise borrowing costs by 25bps, something overwhelmingly supported by market pricing, which indicates a 99.6% probability for such action. Given that a rate hike is fully priced in at this stage, we think that market focus on the day will be on what signals policymakers send regarding the pace of future hikes and specifically, on any potential changes to the "dot plot". In addition, market participants will be looking for clues as to when the Fed will begin normalizing its enormous balance sheet, as the minutes of the May meeting showed "nearly all policymakers" expected it to start later this year.

On balance, we think that the risks surrounding the dollar's reaction from this meeting may be tilted to the downside. In our view, policymakers are highly unlikely to accompany this rate hike with hawkish signals, considering the recent streak of disappointing economic data and developments. Slowing inflation, a sharp decline in inflation expectations, flat wage growth, and diminished expectations regarding the prospect of fiscal stimulus, are all solid arguments supporting a "dovish hike" by policymakers. Our view is enhanced by the latest comments from Fed Board Governor Brainard, who indicated that she sees some tensions between progress in employment and lack of progress on inflation. She added that if this persists, it may lead her to reassess her expectations with regards to the path of the Federal funds rate.

As for the US indicators, we get CPI and retail sales data, all for May. Kicking off with the CPIs, the headline rate is expected to have declined again, albeit marginally. The core rate is anticipated to have held steady. Even though a decline in the headline rate could be a somewhat discouraging development, as long as it remains above the Fed's target and the core rate remains unchanged as expected, we doubt that these data will be a game-changer for FOMC officials.

As for the US retail sales, the forecast is for both the headline and the core rates to have ticked down from previously, but to have remained within the positive territory. The consensus for a slight slowdown in sales is somewhat supported by the nation's consumer sentiment indices for the month. The Conference Board index declined, while the U of M figure remained more or less unchanged. In any case, considering that investors will probably have their gaze locked on the FOMC decision later in the day, a slight slowdown in sales may attract less attention than usual.

In the UK, employment data for April are due out, though no forecast is available yet. Our own view is that the unemployment rate likely remained unchanged, with risks titled to the downside, while average weekly earnings may have risen at the same pace as previously, with risks skewed towards an acceleration. The nation's services PMI for April indicated that job creation in the sector picked up to a four-month high, and that companies reported a strong rise in costs, due to higher salary payments among other factors. Considering that the service-sector accounts for roughly 80% of the nation's GDP, we consider it a decent gauge of the overall economy. However, nominal wages have to accelerate by more than April's inflation for real wages to turn back positive.

In China, focus will be on retail sales, industrial production and fixed asset investment, all for May. All of these figures are expected to have slowed, something that would likely add credibility to the recent signals from the nation's PMIs that economic growth may be easing again. Even though a potential slowdown in all of these indicators would probably be worrisome for the PBoC, we doubt that it will lead to any policy action anytime soon. The Bank has been tightening its policy recently despite signs of slowdown in economic growth and cooling inflationary pressures, mainly in order to curb financial stability risks, such as rapidly rising housing prices.

On Thursday, the Bank of England meets to decide on monetary policy. Expectations are for the MPC to keep policy untouched via a 7-1 vote. Once again, the lone dissenter is very likely to be Kristin Forbes, who has voted in favor of a rate increase in the last two meetings. Nevertheless, this will be the last gathering she participates in as an MPC member and thus, another dissent by her may carry little-to-no importance for market participants. Since the Bank's latest gathering, CPI data showed that inflation accelerated to +2.7% yoy in April from +2.3% yoy the previous month, which is in line with the Bank's forecast for the year, while GDP slowed notably in the first 3 months of the year. These data combined with the fact that in its latest Inflation Report, the Bank downgraded its inflation forecasts for 2018 and 2019, confirm our view that the BoE is likely to remain on hold for this year, and possibly beyond. Just for the record, according to the pound sterling overnight index swaps, the market sees interest rates rising only 10 basis points by 2020. In any case, considering the UK's political situation, with a hung parliament generating uncertainty and the Brexit negotiations set to begin soon, we think that monetary policy considerations will be overshadowed by political developments, at least over the next few weeks.

In Switzerland, the SNB will announce its rate decision and the forecast is for the Bank to keep its policy unchanged. Economic developments have been mixed since the SNB's latest meeting in March. On the inflation front, the CPI rate dropped in April, but rebounded somewhat in May. The unemployment rate ticked down and GDP growth accelerated in Q1, albeit slightly. As for the all-important franc, it appreciated against the dollar, but lost some ground against the euro. Given these mixed developments, we don't expect the SNB to change tune. We think policymakers are likely to repeat the usual mantra – that the franc remains significantly overvalued and that the Bank will remain active in the FX market as necessary in order to curb gains in the currency.

As for the economic data, in the UK, retail sales for May are due out and the forecast is for a decline following a remarkable +2.3% mom surge in April. The forecast is supported by the BRC retail sales monitor, which plunged during the month, with the yearly rate dropping to -0.4% from +5.6% previously. What's more, consumer sentiment indices were downbeat in the month, on balance. The TR/IPSOS figure declined and while the Gfk index rose, it did not manage to escape the negative territory.

From New Zealand, we get GDP data for Q1. Without a forecast available, we see the case for the economy to have grown at the same pace as previously, with risks skewed to the upside. Economic indicators for Q1 painted a relatively upbeat picture. Retail sales accelerated notably in Q1, while the labor market continued to tighten at a very robust pace. However, even in case the GDP print is strong, we doubt that it will have much impact on the RBNZ's cautious bias. In its latest statement, the Bank made it clear that although domestic economic data are improving, numerous uncertainties remain and policy may need to adjust accordingly. Considering that policymakers were probably referring to global uncertainties, and that there have been signs of slowdown in China since that meeting, we think that for the time being, the RBNZ may continue to "look through" encouraging data.

In Australia, employment data for May will be in focus. The forecast is for the unemployment rate to have held steady after declining to 5.7% in April from 5.9% previously. The net change in employment is expected to have declined somewhat, but to have remained in positive territory. The forecast for another month of decent employment gains is supported by the ANZ job advertisements indicator, which showed that job ads rose again in May, though at a slower pace.

On Friday, during the Asian morning, the BoJ policy announcement will be in the spotlight. Looking back at the latest gathering, the Bank upgraded its assessment for the Japanese economy, but revised down its inflation forecasts. Ever since, developments on both of those fronts have been encouraging, on balance. In Q1, the economy grew at the same pace as the previous quarter, while the BoJ's core CPI rate for April rose, albeit marginally. In addition, the nation's forward-looking Tokyo core CPI rate for May rose and entered the positive territory for the first time since late 2015. Last but not least, wages surged by more than anticipated in April, which is likely to be pleasant news for policymakers, as wage growth is seen as a signal of future inflation. Nevertheless, we do not expect such modest signs of progress to lead to any change in the BoJ's QQE with yield-curve control framework, at least for the next few meetings.

Following the UK elections, the focus next week will continue to be on Britain as the outcome of the vote could have important ramifications for Brexit negotiations. Key events in the coming week revolve around central banks as the Bank of England, Federal Reserve and Bank of Japan all have policy meetings next week.

Bank of England

The Bank of England is widely expected to leave interest rates at 0.25% and it is considered unlikely that the Bank will cut rates further in response to the result of the vote as they did after the Brexit result last June. But if the UK economy suffers as a result of uncertainty from the new coalition Government then rates are set to stay low for the foreseeable future. Meanwhile, employment data will provide a key indication of the health of the labour market, while the May retail sales report is also due and are expected to drop 0.8% from April's 2.7% increase, the biggest gain since January 2016. Inflation data will be closely watched as well next week. CPI jumped to 2.7% in April from 2.3% in March, the highest since mid-2013. However, wage growth lagged inflation for first time since mid-2014. BoE policymakers attribute almost all of the inflationary upsurge to drop in the value of the pound since the Brexit vote.

Federal Reserve policy meeting

All eyes will be on the FOMC meeting, with high expectations for an interest rate hike of at least 25 basis points to bring the Fed funds rate to between 1.00-1.25%. The Fed's quarterly economic projections and Chair Janet Yellen's speech will be closely scrutinized. The data flow recently has been disappointing and this has reduced the odds of aggressive rate hikes after June. Aside from the weaker data, political controversies surrounding US President Donald Trump have led to growing doubts about the Trump administration's ability to pass tax and healthcare reforms through Congress. A slew of US economic data due next week includes CPI, PPI, retail sales, unemployment claims, industrial production, building permits, the preliminary University of Michigan consumer sentiment report and the Empire State manufacturing index.

Bank of Japan

Japan's central bank is not expected to make any changes to monetary settings as the Japanese economy is still a long way from meeting the BOJ's 2% inflation goal. Data that might be worth watching will be machinery orders for April. They are forecast to fall 1.3% month-on-month from a prior 1.4% gain.

China IP

Other key data highlights include China's data releases on industrial production and foreign direct investment and retail sales.

Australia and New Zealand

Jobs data are due from Australia, as well as the NAB business confidence survey. New Zealand releases GDP numbers.

Eurozone

The week also sees data out of the Eurozone which include industrial production and CPI as well as the German ZEW report.

• With Events Out Of The Way, Buy Risk - Peter Rosenstreich
• SNB's Period Of Relaxation Is Over - Arnaud Masset
• ECB Meeting: Draghi Disappoints Markets - Yann Quelenn
• "Brexit"

Economics - With Events Out Of The Way, Buy Risk

This last week has provided plenty of risk events that shifted investors' attention from fundamentals and on to flashy headlines. While the result of the hung parliament in the UK will likely hurt GBP and UK assets for the foreseeable future, the other key events will have only a transitory effect. While rogue bouts of risk aversion have provided a white-knuckle ride, we remain constructive on EM currencies based on fundamentals. The drivers of strong capital inflow, which have supported EM assets, are unchanged and are showing no signs of diminishing.

Emerging / developed markets growth differentials will support asset prices. The positive economic surprise in many EM nations has lifted the EM growth outlook. EM GDP for 2017 is expected to come in near 4.5%, well outpacing developed nations' soft 1.8% expansion. Yet, politics both domestically and internationally, such as President Trump's trade policy, provide a significant level of uncertainty to this forecast. Inflations remain in a sweet spot for investors. Solid economic activity, specifically in trade, has pressured price yet soft crude prices has pushed back on the reflation theme. Central banks are likely to keep policy loose as the outlook for energy prices remains subdued.

However, the strongest driver of EM appreciation is likely to be the delay of monetary policy tightening by the big three. Last week, the ECB lowered inflation outlook, which allowed Draghi to provide a dovish tone, despite clear movement toward the exits. The BoJ in comments are ready to let inflation overshoot despite general economic improvement and increasing pressure from politicians to begin normalisation.

Finally, this week's Fed 25bp hike is nearly completely priced in yet the probably of additional hikes in 2017 collapses. Disappointing US economic data (including weak core inflation data) and confusion in Washington has sapped investors' confidence of 2Q acceleration and therefore an aggressive Fed interest rate curve. With no impending G3 tightening, sustained higher volatility is unlikely benefiting EM in the mid-term.

Overall, global macro environments remain supportive to risk-taking and will further drive flows into EM assets. We continue to favour carry trades but remain nimble for shifts in sentiment.

Economics - SNB's Period Of Relaxation Is Over

The publication of the latest batch of economic data from Switzerland went largely unnoticed as market participants awaited several key events. The unemployment rate eased to 3.2% (seasonally adjusted) in May, beating median forecast of 3.3%, while the previous month's figure was downwardly revised to 3.2%. Investors also got a positive surprise on the inflation front as the headline measure printed at 0.5% y/y, well above estimates of 0.3%.

However, the HICP measure, which allows to compare inflation pressure with that of its European neighbours, shrunk 0.2% m/m in the previous month. On a year-over-year basis, the indicator eased to 0.4%, down from 0.7% in April. There is no reason to worry as core inflation continued to accelerate in May, highlighting the negative effect of the most volatile components, especially petroleum products.

On the monetary policy side, the SNB has had some respite over the last few weeks as investors renewed their faith in a strong European Union amid Macron's victory at the French presidential election and an expected positive outcome for the Conservatives in the UK. The pace of increase of sight deposits within the Swiss National Bank have slowed down substantially during the weeks following the election of Macron as total sight deposits rose by a weekly average of CHF 357 million compared to almost CHF 2 billion during the month previous to the election. As of June 2nd, total deposits printed at a new all-time high and topped CHF 576 billion.

Yet the honeymoon may be over as both the political and monetary environments have worsened recently. Indeed, Mario Draghi's dovish speech last Thursday, together with May's failed attempt to reinforce its position in the House of Common, will put investors on the back foot and incite them to cut their long EUR position, which would ultimately weigh on EUR/CHF.

We expect EUR/CHF to come under renewed downside pressure as investors adjust their portfolio. After hitting 1.0987 amid Macron's victory, the pair has kept on moving lower to reach 1.0838 last Friday. In the short-term, we anticipate the single currency to return to around 1.0650.

Economics - ECB Meeting: Draghi Disappoints Markets

The euro has weakened amid the ECB meeting last week. The European Central Bank has slightly lowered its inflation forecast. Indeed the CPI expectations are now 1.5% in 2017, 1.3% in 2018 and growth should remain below 2% within the next three years.

Financial markets were clearly expecting for hints about a possible normalization of the monetary policy as we can consider the massive easing did not yet have the expected results. Actually Draghi mentioned that rates could go further lower despite what appeared to be the current ECB political stance. Concerns are also coming from German Chancellor Angela Merkel and also from Dutch officials. Recently at the end of a meeting with the Dutch parliament, Draghi was offered a plastic tulip to remind of bubble concern.

As widely expected, the rates remain unchanged. In our view, we still believe that we are approaching towards an inflexion point regarding monetary policy

In order to assess the Eurozone economy, the German economy is a great barometer. Last week, German Factory orders declined - surprisingly - more than expected in April at -2.1% m/m. Anyway, recent economic data were robust and showed that Germany was on a strong recovery road.

The factory orders forecast, even though negative, was way more optimistic. Markets estimated the data to slightly decline to -0.3%. We now wonder whether there is a reason to worry after the very positive first half of the year. It is anyway important to notice that the annualized data remains largely positive with a +3.5% print.

As explained above, other German economic fundamentals are positive. Growth is running at a strong pace above Eurozone average at 0.6% for Q1 and the labour market is widely recovering.

Unemployment has never been so low. So last week's factory orders seem to be contradicting the current momentum in Germany.

Amid the release of this German data and the ECB meeting, the single currency is trading mixed and is now back below 1.1200. We believe that markets are still optimistic of the Eurozone recovery and continue pricing in US difficulties.

Themes Trading - "Brexit"

The decision of the United Kingdom to leave the European Union turned upside down financial markets as most investors were anticipating the UK to vote "no" at the EU referendum. This decision triggered a panic reaction in financial markets with investors fleeing risky assets to invest massively in safe haven ones such as gold or bonds. However, even though most equities suffered a massive sell-off, a few ones were to weather the turmoil.

The portfolio we built a portfolio composed of stocks that are expected to perform well in case of a Brexit. The portfolio offers a substantial indirect exposure to gold, which always performs well during turbulent periods due to its safe haven status, as well as stocks weakly correlated with equity indices, which usually performs well during period of high volatility.