- 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.
