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Amid UK/US political fallout, central banks to dominate the week ahead

UK Election Bombshell

The UK election has come and gone, and the outcome could hardly have been more dramatic. In the wake of a hung Parliament, where UK PM Theresa May’s Conservative Party failed to gain an overall parliamentary majority despite garnering more votes than any other party, May announced intentions on Friday to align with Northern Ireland's Democratic Unionist Party in forming a coalition government. While sterling plunged on the release of exit poll projections Thursday evening pointing to a likely hung Parliament, the currency stabilized on Friday as Theresa May tentatively soothed severe concerns over the future of UK politics and the looming start of Brexit negotiations with the European Union. This is not at all to say that the British pound is now free and clear of pressure and market worries. On the contrary, ongoing uncertainties within the UK government and surrounding Theresa May’s mandate to lead negotiations are likely to continue weighing on the pound as the inevitably difficult Brexit process begins.

Comey Testimony and Trump Response

In the US, Thursday’s Senate testimony of former FBI Director James Comey regarding allegations that President Trump attempted to obstruct justice provided very little in the way of any new or substantive information. In a nutshell, Comey essentially called Trump a liar in front of the Senate committee, and then Trump later shot back on Twitter calling Comey both a liar and a leaker. Trump also claimed “total and complete vindication” in a tweet after the testimony, despite some highly damaging comments by Comey. While more substantial information is likely to emerge in the coming days and weeks, markets simply shrugged off the testimony on Thursday, as the Dow reached a new record high. US equity markets continued to rally early on Friday – not only shrugging off Comey’s testimony, but also ignoring the surprise UK election outcome – as the Dow, S&P 500 and Nasdaq indices all reached new all-time highs shortly after markets opened.

Central Bank Market-Movers

Looking ahead to next week, political fallout from the UK election and the ongoing Trump/Comey saga should continue to make headlines, but four major central bank decisions are set to dominate market movement, particularly with respect to currencies. The most highly anticipated of these central bank decisions will be the long-awaited June Federal Reserve decision on Wednesday. Despite a weaker-than-expected jobs report released last week, which featured not only a relatively low rate of job creation in May but also significant downward revisions to previous months’ data, markets are almost unanimously expecting a Fed rate hike on Wednesday. According to the CME Group’s FedWatch Tool, traders are pricing-in more than a 99% likelihood as of Friday that the Fed will raise interest rates by another 25 basis points. Due to this remarkably high market-viewed probability, any ultimate failure to hike on Wednesday should result in an exceptionally negative impact on the US dollar. But even if rates are increased as expected, key questions center around the future of Fed policy in the second half of 2017 and into 2018 given relatively lackluster economic data as of late. The past few days have seen a modest rebound for the US dollar, but this has only occurred after a prolonged drop. Wednesday’s FOMC decision and accompanying Fed comments on the economy should play a key role in whether the dollar extends its short-term rebound or continues its slide.

Rounding out next week’s central bank decisions will be the Swiss National Bank (SNB) and Bank of England (BoE) on Thursday, followed by the Bank of Japan (BoJ) on Friday. The SNB is expected to keep the Libor rate steady in negative territory with a midpoint at -0.75%, but could also continue to state that the Swiss franc is overvalued, especially after the sharp rise in the franc against the US dollar within the past month. The BoE is also expected to keep its official bank rate steady – at 0.25%. Last month, the central bank revised down both its longer-term inflation and economic growth forecasts as it kept rates unchanged, leading to a drop for sterling. How this week’s UK election outcome and resulting currency volatility may or may not affect the BoE’s policy stance remains to be seen next Thursday. Finally, the Bank of Japan announces its decision on Friday. Negative rates are expected to remain unchanged and monetary policy is not expected to tighten in the foreseeable future, but any signals by the BoJ on inflation or its massive bond purchasing program will likely impact the Japanese yen, which has been strengthening sharply against its major currency counterparts within the past month.

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