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Political developments were dominating investors' attention today with the outcome of British national elections and the effect on sterling being number one on the watch-list.

Less than two weeks' time before Brexit negotiations get underway, UK Prime Minister Theresa May's Conservative party lost its majority in the House of Commons. May's call for snap elections was in the first place intended to give her a stronger hand in negotiating the nation's exit from the EU and the outcome turned out to be what she least likely wished for, introducing an additional layer of uncertainty going forward. Reports suggested that May would seek to gain Northern Ireland's Democratic Unionist Party support in order to secure parliamentary majority and govern the nation.

Sterling tumbled as the polls hit the markets. Relative to the dollar it fell by almost two and a half cents to reach a low of $1.2704 from the $1.2950 level it traded before, reaching a near two-month low. At the same point in time, the euro recorded a steep rise relative to the pound, rising to as high as 88.24 pence from 86.54. Later in the day, euro/pound posted a seven-month high of 0.8858. By afternoon European trading hours the British currency managed to recover part of those losses but was still significantly down on the day relative to both the greenback and the euro.

The former FBI director Jamey Comey's testimony before the US Senate was largely ignored by the currency markets despite him accusing President Donald Trump of lying and thus potentially diverting his administration's attention from delivering on campaign promises, such as a tax system overhaul. The focus now shifts to the Federal Reserve's policy meeting next week and predominantly on guidance on rate normalization moving forward, as a quarter percentage point interest rate hike seems to be already priced in by the markets. The CME Group's 30-day Fed Fund futures prices currently reflect a more than 90% chance of that materializing.

Dealing away with the week's risk events and being helped by rising US yields, the dollar index, a broader measure of dollar strength, opened with a gap higher that was mainly fueled by the greenback gaining versus the pound. The index was up by half a percent in late European trading hours at 97.38. Dollar/yen was last comfortably above the 110 level after starting the day slightly below it. Euro/dollar hit a more than one-week low of 1.1166 with the single currency building on negative momentum after the European Central Bank's decision yesterday to cut its inflation forecasts and the Bank not being ready yet to reduce its monthly pace of asset purchases.

Turning to today's data releases, UK industrial output numbers for the month of April showed output growing by 0.2% month-on-month, well below the 0.8% expected but above the 0.5% contraction in the previous month. Manufacturing output, a subset of industrial output, also grew by 0.2% on a monthly basis. Expectations were for growth to reach 0.9%, while March's respective figure stood at -0.6%. Both manufacturing and industrial output experienced contraction in January and February as well. In other UK data, the nation's goods trade deficit narrowed to 10.4 billion pounds in April with analysts expecting a 12.0bn deficit. Both exports and imports fell, with imports falling more sharply and thus resulting in a narrowing deficit. The pound didn't have much of a reaction to the data.

In other releases, the Canadian economy added 54,500 jobs in May, far exceeding projections of 11,000 additions and April's 3,200. The unemployment rate increased to 6.6% from 6.5% in the previous month, in line with expectations. The rise in the unemployment rate was attributed to more individuals entering the labor force (i.e. there was an increase in labor force participation), a positive for the economy. Also positive was the fact most positions added were full-time in nature. Dollar/loonie strongly reacted as the data hit the markets with the Canadian dollar gaining relative to its US counterpart. Specifically, dollar/loonie fell to as low as 1.3458 within a five-minute time frame of data release from 1.3511 previously. The pair was last further down at 1.3442.

Finishing with gold, as funds moved back into the dollar, the precious metal continued its retreat and looks set for a third straight daily decline. Today it recorded a one-week low of $1264.50 an ounce.

Market Movers ahead

• In contrast with the consensus expectation and market pricing, we think the Federal Reserve will keep rates on hold when it meets on Wednesday and instead make an announcement on balance sheet reduction.
• We expect US CPI inflation was 2.0% y/y in May down from 2.2% y/y in April.
• In the UK, the market will focus on the ramifications of the election results. Also the Bank of England will meet on Thursday.
• In Denmark and Sweden, attention will be on the release of CPI inflation data for May.
• The regional network report from Norway should paint a benign picture of the economy.

Global macro and market themes

• Markets are increasingly diverging with stocks keeping an upbeat tone while bond yields, commodity markets and inflation markets have moved lower.
• We see a rising discrepancy between the strong equity markets and disappointing data recently.
• We still recommend a more cautious stance on stocks in the short and medium term.
• Bund yields are set to stay in range.
• EUR/USD lower short term – higher medium term.

Full Report in PDF

• A weakened Theresa May began to form a fragile new U.K. government today as she battled to stay on as prime minister despite losing her parliamentary majority in a disastrous election gamble. May's Conservatives will need support from Northern Ireland's Democratic Unionist Party in order to pass laws in the House of Commons.
• The Catalan government announced today its plans to hold an independence referendum around October. The central government will challenge the legality of the referendum. This challenge will likely be upheld by the Spanish courts, potentially forcing the Catalan government into a position of open defiance against the country's judiciary.
• The UK economy had a weaker-than-expected start to the second quarter as industrial and manufacturing production posted only small increases (both +0.2%), after months of falling figures. ONS data showed the UK's goods trade deficit narrowed to £10.4bn mostly due to a fall in goods imports, almost reversing the surge in March.
• The markets are remarkable stoic by the first round of the National Assembly election in France this Sunday. The contrast with the presidential elections in May could not be bigger. Opinion polls currently predict Macron's party will gain around 30% of the votes on in the first round.
• As markets digested today's unexpected UK election results, Sterling depreciated strongly. This gave the FTSE 100 a boost, but the election's impact beyond the U.K. was muted. The other main equity indexes worldwide performed well today with Nasdaq reaching an all-time high today. Meanwhile, fears of a supply glut continue to weigh on oil.

Rates

Bonds hover sideways before profit taking kicks in

Today, despite the surprise UK election result, global core bonds hovered directionless in a tight range. The Conservatives lost their majority and have to start the Brexit negotiations with a weaker hand and a lame duck Prime Minister. That creates uncertainty, but core bonds couldn't gain. After a minor reaction to the soft ECB message yesterday, there was no follow through buying. The Bund meandered in a 164.90 to 165-10 range, after a slightly higher opening. Similarly the US T-Note future temporary spike during the Asian session (on the UK election result) but showed little animus during the European session, staying close to Thursday's official close. Going into the European close, core bonds slide slightly lower, maybe due to profit taking ahead of the weekend, given the preponderance of the long positions. The move lacks momentum though. Eco data were second tier and didn't impact trading. The German trade surplus was lower than expected, but due to a stronger increase of imports than exports, which suggests good domestic growth. French production fell more than expected, but following an outsized increase in the previous month. ECB Nowotny was quite dovish in his comments, saying the ECB took homeopathic changes to its guidance. He also sees downside risks to the ECB inflation forecasts, which are a challenge for the ECB. His comments didn't affect trading.

At the time of writing, the German yield curve bull steepens with yields 0.3 bp (2-yr) to 2.9 bps (30-yr) higher. US yields rise by 2.7 bps (2-yr) to 3.5 bp (5-yr), the belly underperforming the wings. On intra-EMU bond markets, 10-yr yield spread changes versus Germany continue to narrow on heavy follow through buying up to 6 bps (Spain/Greece) with Italy outperforming (-10 bps). Italian BTP's performed strongly on a positive APP ECB decision and as Italian early election plans took a snag.

Currencies

EUR/USD off the recent highs as Draghi stays soft

Today, the swings in the major cross rates excluding sterling were modest. In a session deprived of important eco data, the dollar continued yesterday's gradual comeback. At the same time, yesterday's cautious ECB approach also capped the topside of the euro. EUR/USD dropped below 1.12 (currently 1.1168). USD/JPY extended its journey north of 110 (currently 110.65).

Overnight, Asian equities traded mixed. The UK election result dominated the headlines, but was no big issue for Asian trading. The dollar maintained yesterday's limited gains. USD/JPY changed only modestly and traded in the low 110 area. EUR/USD lost a few ticks as cable sold off early in Asia, but changes were also limited. The pair again traded in the 1.12 area going into the start of European trading.

Continental European markets had a very calm trading session despite the high profile political events on the other side of the English Channel. European yields declined briefly in early dealings, but soon returned to yesterday's post-ECB levels. EMU eco data were second tier and had no impact on markets. The EMU equity markets remained well bid and completely ignored the UK uncertainty. In the FX market, yesterday's trading pattern more or less continued. The dollar showed tentative signs of a bottoming-out process and this cautious USD bid persisted. The Comey testimony is out of the way and didn't really bring negative news for President Trump. At the same time, the topside momentum of the euro has disappeared after yesterday's relatively soft ECB communication. Interest rate differentials widened slightly in favour of the dollar. EUR/USD drifted below the 1.12 mark (currently 1.1175). USD/JPY also rebounded further from the recent lows and traded in the 110.45 area. Will the USD momentum improve further next week going into the Fed policy decision?

Sterling facing political headwinds

This morning, investors adapted sterling positions as UK PM May's conservative party lost its majority in Parliament. The election outcome created an instable political context going into the Brexit negotiations and raised uncertainty on the short term UK growth outlook. Sterling selling started in Asia as soon as it became clear that the UK was heading for a hung Parliament and reaccelerated at the start of trading in Europe. EUR/GBP tested the 2017 top in the 0.8855 area. However, no sustained break occurred. On the contrary, the UK currency gradually found its composure and rebounded. Markets pondered whether the new political context could lead to a softer Brexit. Such a scenario could be less negative for sterling. The jury is still out on this issue as UK PM May joined forces with the Northern Irelands DUP. EUR/GBP currently trades in the 0.8775 area. Cable is changing hands in the 1.2735 area.

EURAUD made a sharp and strong fall away from 1.5226 high, where we labeled end of red wave 5). As such current fall may be start of a bigger three wave correction, with wave A) already completed. Current slow price action can be the second red wave B) in the making, with price now specifically trading in sub-wave B. A bounce into wave C is expected to follow, with a Fibonacci resistance ratio of 50.0 or 61.8.

EURAUD, 1H

China's headline CPI inflation accelerated to +1.5% y/y in May, from +1.2% a month ago. for the first 5 months of the year, CPI has stayed at average of +1.4%, amongst the lowest levels in history. Core inflation steadied at +2.1% in May. Non-food CPI moderated to +2.3% from 2.4% in April. Food inflation remained in contraction but the decline narrowed to -1.6% y/y in May from -3.5% in the prior month. We believe it was the low base that had helped improve the reading. PPI inflation continued to slow, falling to +5.5% y/y in May from +6.4% in April. Weakness in commodity prices is expected to weigh on PPI, sending it lower to around +5% in coming months.

Trade

Both of China's exports and imports growth exceeded expectations in May. Exports growth accelerated to +8%y/y from +8.7% a month ago, thanks to the strong increase in shipment to the EU and, to a lesser extent, South Korea. Notwithstanding the high base the same period last year, imports growth accelerated to +14.8% y/y from +11.9% in April. G3 imports surged +15.6% in May, up from +3.6% y/y a month ago. Meanwhile, imports from the US jumped +27% y/y last month, compared with April's +1.5% growth. The country's trade surplus widened to US 40.8B in May, from +US$ 38.1B in the prior month. Indeed, we mentioned in our previous report that the widening gap between exports and imports in the official manufacturing PMI report signaled stabilization in China's trade balance.

Looking into commodity sector, China imported 8.8M bpd of crude oil in May, up 4.6% m/m and 15.4% y/y. The country's imports were mostly heavier, sweet West African grades. Net exports for preliminary petroleum product increased to 401M bpd in May, up +40.8% from the prior month. From a year ago, net exports of which soared +73.9%.

FX Reserve

Separately, PBOC's FX reserve increased +US$ 24B to US$ 3.054 trillion, highest in 7 months, in May. This beat expectations of a +US$ 16B increase. The reading remains largely unchanged after adjusting for currency valuation effects. China returned to FX accumulation over the past few months as it faces less pressure on renminbi depreciation, thanks to its stringent capital control measures and Weakness in Us dollar. Note that USD tumbled to a seven-month low in recent weeks and sank -2.5% in May. We expect to see less aggressive sale of FX reserve for supporting renminbi in the futures as China has decided to add a "counter cyclical adjustment factor (CCAF)" to calculate renminbi. While such "factor" might lower the volatility of renminbi, its ambiguity would only make the movement of currency even less transparent.

GBPAUD focus is to the downside after a break below the 50-day moving average and below the key psychological 1.7000 level.

Oscillators are showing that the downside bias is gathering momentum. RSI is trending down and is below 50 in bearish territory, pointing to the possibility of further downside in the market. Other momentum indicators such as MACD and the stochastics are also showing a bearish bias.

Prices are currently holding above the 200-day moving average which will provide support at 1.6680. A break below would bring about more weakness in the market and accelerate a further decline. Next support would come into view at 1.6240 before 1.5902 (March 16 low).

As long as the market can stay above the 200-day moving average, the uptrend that took place from 1.5902 to 1.7650 will not change. But the short-term bias is to the downside and the medium-term outlook is neutral.

The outcome of the UK general election has resulted in a Hung Parliament.

Updated seats breakdown of UK general election so far is: Conservatives 318, Labour 261, SNP 35, Liberal Democrats 12 other parties 23. Following this result the Conservative Party has lost their majority in the House of Commons and will now be looking for a partner to form a coalition - likely to be the DUP.

Following the Exit Polls, that were released at 22:00 BST last night, GBP/USD saw its biggest intra-day fall of 250 pips (2.44%), since October 7th.

The sharp drop broke two major support lines at 1.2900 and 1.2800. The fall was held temporarily after testing the significant support line at 1.2700 and seeing a 130 points rebound.

Following the rebound GBP/USD continued trading down trading as low as 1.2634, last seen on April 18, as markets realised that a majority UK Government was unlikely.

On Friday, during the European session, Cable saw a notable rebound and is currently holding above 1.2700, trading around 1.2725, indicating waned bearish momentum.

GBP/USD is likely to oscillate in the range between 1.2700 - 1.2800 for an extended period.

The 4-hourly Stochastic Oscillator is below 30, suggesting a rebound.

The resistance level is at 1.2750, followed by 1.2780 and 1.2800.

The support line is at 1.2630, followed by 1.2700.

Canada added a healthy 54.5k net jobs in May. The previous month's drop in the labour force more than reversed (+78.4k in May), enough to move the unemployment rate a notch higher to 6.6%.

It was full-time work that led the gains, up 77k positions, while part-time employment fell 22.3k positions on net. Canada has added 185.1k net full-time positions so far this year, well ahead of the 27.9k net added at the same point in 2016.

It was largely the private sector leading the way, adding 59.4k net jobs, more than reversing April's declines. The public sector remained a net job creator as well (+9.2k).

Job creation was seen in both the goods-producing (+23.3k) and service-producing (+31.3k) sides of the economy. The goods side was largely a story of manufacturing (+25.3k) as the other major sectors turned in flat performances. Within services, professional services (+25.9k), transportation (+17.1k), trade (+15.2k), and health care (+15.1k) were the star performers. In contrast, finance, insurance, real estate and leasing saw a loss of 17.4k net positions, and a sizeable decline was also seen in information, cultural, and recreation (-15.8k).

Regionally, it was Ontario (+19.9k), Quebec (+14.9k), and B.C. (+12.3k) that led the gains. Job growth in the other provinces was effectively flat. Notably, a shrinking labour force in Quebec led the unemployment rate down to 6.0% (from 6.5%), while in Ontario, it was the opposite story, as rising participation swamped job gains, leading to a 0.7 p.p. climb in the unemployment rate, to 6.5% (reversing the previous month's declines)

Hours worked were up a modest 0.7% year-on-year (April: +1.1%), while the hourly wage rate gain 1.0% year-on-year, an improvement from the record slow pace recorded in the month prior.

Key Implications

This is a report with a lot to like in it. May recorded the biggest monthly net jobs gain since September of last year (and the best performance year-on-year since February of 2013), largely on gains in full-time work. Moreover, gains were spread across most sectors, with solid private sector hiring activity. Even the modest uptick in the unemployment rate is a welcome development as it reflected a labour market that drew Canadians back in. Indeed, among Canadians aged 15 to 64 years, the participation rate remains near all-time highs.

The soft spot in Canadian labour markets remains hours worked and wages. Growth in hours worked has improved in recent months, but remains somewhat soft, particularly given the healthy gains in full-time work. Similarly, wage growth may have recovered from last month's low, but at 1.1% year-on-year, remains soft by any measure.

The May jobs report provides further indication that the Canadian economy is likely to remain fairly robust in the second quarter. Wage growth may remain a soft spot for now, but the healthy labour market, including strong core participation rates, should continue the upward pressure in wages, and prices more generally. We remain of the view that the pieces are falling in place to allow the Bank of Canada to begin tightening monetary policy early next year.

The CAC index is showing little movement in the Friday session. Currently, the CAC is at 5275.00 points. On the release front, there are no major events on the schedule. French Industrial Production was soft, posting a decline of 0.5%. This was well short of the estimate of +0.3%.

There were no major moves from the ECB at the June policy meeting, as the central bank held course on interest rates and the quantitative easing program (QE). The central bank maintained the benchmark rate at 0.00%, and kept QE purchases at EUR 60 billion/month. However, the ECB did remove its guidance on rate cuts, saying that rates could remain at current levels for an extended period. Effectively, the ECB has closed the door on lowering rates into negative territory, barring a nosedive in economic conditions in the euro-area. As well, the ECB revised upwards its growth forecasts for the eurozone – from 1.8% to 1.9% in 2017, and from 1.7% to 1.8% in 2018. Analysts also noted a shift in language, as Draghi characterized risks to the economy as "broadly balanced", compared to previous warnings that risks were "tilted to the downside". However, low inflation levels remain a serious concern, and the ECB acknowledged this, lowering its inflation forecast. The ECB is now predicting inflation in 2017 at 1.5% in 2017 and 1.3% in 2018. Back in March, the forecast stood at 1.7% in 2017 and 1.6% in 2018. The ECB is not expected to revisit its monetary policy until the September meeting. Drahgi and his colleagues appear in no rush to tighten monetary policy, but at the same time, policymakers carefully chose less dovish language in the rate statement, in order to relieve pressure from Germany, which has been outspoken in demanding tighter monetary policy.

The stunning results in the British elections, which saw the Conservatives squander their majority, has overshadowed the upcoming French parliamentary elections. Unlike the election campaign across the Channel, the outcome is much less uncertain, as French President Emmanuel Macron is widely expected to cruise to victory. Opinion polls are showing that Macron's LREM party, which is barely one year old, has 30% of votes, with the conservative Republicans trailing at 22%. The polls, which were quite accurate in last month's presidential election, are predicting that Macron will win a convincing majority in parliament. Macron, a strong supporter of the European Union, is expected to implement pro-business reforms and streamline government. The young and charismatic Macron is expected to be a strong ally of German Chancellor Angela Merkel, who herself will face the voters in a September election.

Highlights:

• Employment jumped a much-stronger-than-expected 55k in May. Markets expected a 15k gain.
• Full-time employment was up 77k to more-than-offset a 22k drop in part-time.
• The unemployment rate inched up to 6.6% from 6.5% in April as labour force participation rose.
• Year-over-year wage growth for permanent employees remained modest but rose to 1.0% from the all-time low 0.5% in April

Our Take:

The jump in employment in May continued an unusually long streak of gains for a survey that is typically very volatile. The 55k surge in employment marked the 16th gain out of the last 18 months. Average growth over that period has been 21k. The unemployment rate ticked up to 6.6% from the cycle-low 6.5% in April but because of a jump in the labour force. The measure was still down 0.3 percentage points from a year ago and there is little evidence that factors like worker discouragement or involuntary part-time employment have been behind recent declines. The labour force participation rate is close to all-time highs when controlling for the aging of the population.

Wages remain the soft-spot although annual growth in permanent employee wages rose to 1.0% from the all-time low 0.5% increase in April. Other wage measures have, though, been somewhat stronger. Compensation-per-hour worked was up 2.5% year-over-year in the first quarter and wage growth in the alternative 'SEPH' labour force survey for Canada was 2.4% year-over-year in March.

Strengthening in labour markets and stronger recent GDP growth numbers increasingly argue that current ultra-low interest rates may no longer be needed to support the economy. We nonetheless, continue to expect slow wage growth, lack of upward pressure in consumer prices, and uncertainty about U.S. trade policy during the upcoming NAFTA renegotiation will keep the Bank of Canada cautious and don't expect a rate hike until the first half of 2018.