Opinion polls have shown remarkable consistency over the past six weeks. Despite a four-point drop for the opposition Labour Party, a final YouGov poll suggests they are still on track to achieve the largest majority for any single party since 1832. Meanwhile, the ruling Conservatives have fallen by three points, the Liberal Democrats have gained one point, and Reform UK has increased by five points. The UK's ruling Conservatives are facing potential electoral defeat today, but the extent of the loss remains uncertain. Exit polls around 10pm should provide a clearer picture of the final outcome.

How might markets react? The muted response in gilts and sterling during this election campaign suggests that investors expect Labour to maintain fiscal stability. However, if Labour forms a minority or coalition government, markets might react negatively due to renewed fears of political instability. Current polls indicate a large Labour majority of 90-200 seats, with Conservative seats projected between 53 and 155. The incumbent party hopes the polling industry is underestimating them, as it did in 1992, but even a similar polling error would only give the Tories around 170 seats, far short of the 325 needed for a majority. With a majority of 50-100 seats, Labour should be able to implement its policy agenda, focusing on fiscal prudence and gradually moving towards closer alignment with the European Union (EU).

This could benefit UK growth and is one reason why GBP has risen since the election was called, reaching two-year highs of €1.19 against EUR and nearing $1.28 versus USD. The long-term outlook for sterling might become more bullish given Labour's intention to strengthen UK-EU trade relations, which should gradually reduce the pound's Brexit premium.

In the FX options market, the cost of insuring against FX volatility around the election date has remained relatively low, indicating investor confidence in the outcome. The election's impact on the pound will likely come from the lifting of the Bank of England speaker blackout. The interest rate narrative will ultimately drive the pound's direction in the coming weeks and months, so markets will welcome new guidance ahead of the BoE's next meeting in August.

The US dollar initially weakened after Federal Reserve (Fed) Chair Jerome Powell stated that disinflation appears to be resuming, ending a two-day selloff in the bond market and exerting downward pressure on US yields and the dollar. However, the US JOLTS report suggested the labour market might be strengthening, with job openings and hiring on the rise. This development is bearish for bonds but bullish for the dollar ahead of Friday's jobs data. Despite this, the US dollar index still ended the day slightly lower, with a significant upward tail, indicating bullish fatigue.

Powell warned that maintaining a restrictive stance for too long could cause unnecessary economic pain, but cutting rates too soon could undermine progress in bringing inflation towards the 2% target. The US 2-year yield fell below its 200-day moving average following these comments. Although Powell acknowledged the labour market is becoming better balanced, reducing the risk of another inflation surge, the JOLTS job openings report released shortly afterward exceeded expectations, rising by 221,000 to 8.14 million in May, above the forecast of 7.9 million. This halted the decline in the job openings-to-unemployed ratio, a key labour market indicator for the Fed. Nevertheless, the trend is softening as the US economy moves towards pre-pandemic levels, leaving the possibility of rate cuts later this year open.

We believe the current macroeconomic backdrop supports the expectation of a Fed rate cut in September. Signs of the US economy losing momentum are increasing, with last week's macro data consistently disappointing. Attention is now on Friday's jobs report, the ISM services PMI, and the Fed's meeting minutes today. However, until the Fed starts easing and political risks diminish, the high yield and safe-haven appeal of the US dollar might keep it strong for a while longer.

The euro retreated after a three-day advance, mirroring the performance of most G10 currencies, as ECB policymakers indicated they need more evidence that price pressures are under control. European stocks fell, erasing over half of the previous day's gains, amid ongoing French political uncertainty ahead of Sunday's final round of voting. European government bond yields also declined, but the OAT-Bund 10-year yield spread, a proxy for the French election premium, narrowed further to 72 basis points (-6 bps from Monday), the lowest in almost three weeks.

The preliminary annual inflation rate in the Eurozone eased to 2.5% in June, down from 2.6% in May, aligning with market expectations. Core inflation, which excludes volatile items like food and energy, unexpectedly remained unchanged at 2.9%. The services inflation gauge also held steady at 4.1%. While the headline trend is promising, ECB President Lagarde stated at the ECB Forum that there is not yet sufficient evidence that inflation threats have passed. The region's resilient labour market allows the ECB time to evaluate the appropriate timing and pace of its monetary policy easing cycle but also contributes to upward wage pressures, especially in the services sector, where labour costs significantly influence prices. Currently, money markets are pricing only a 7% probability of a consecutive rate cut in July, consistent with recent ECB communication, and expect 41 basis points of additional easing by year-end.

Realized FX volatility across euro crosses decreased as markets digested key takeaways from the first round of the French parliamentary elections, leading to a wait-and-see approach. The 1-week implied volatility, an option-based measure of short-term expected future volatility, slightly retreated but remains elevated compared to the 2024 average, with near-term market sentiment staying bearish on the euro.

This time tomorrow, British voters will head to the ballot box, with polls still indicating a substantial lead for the Labour Party. Although the lead has slightly narrowed, Keir Starmer's opposition party still holds over a 20-point advantage. Typically, markets are wary of a leadership change, especially with a left-leaning Labour Party. However, this time the markets are hopeful that Starmer’s more centrist, pro-business stance—promising fiscal discipline and improved EU relations—will bring more stability to the UK economy and politics, reassuring investors and boosting the pound.

Currently, amidst this potential Labour victory, rather than being spooked, markets are thriving: British stocks are near record highs, UK bond volatility has diminished, and the pound is the best performing G10 currency year-to-date after the US dollar. Hedging against pound weakness is at a seven-year low. This is a welcome change, given how UK assets have been affected by political drama for many years. Some investors are even betting that UK assets will provide a refuge from political chaos elsewhere, such as in France and the US. However, surprises in politics or markets can never be ruled out, so we remain cautious of potential volatility and unexpected FX movements. The biggest downside risk for the pound would be a hung parliament, where no party has a majority of seats. This scenario, seen in the 2010 and 2017 elections, led to the pound losing over 4% in value within a week. However, this is not our primary expectation.

GBP/USD has risen for four consecutive days, flirting with its 50- and 100-day moving averages, and is in neutral territory according to momentum indicators like the relative strength index. To increase the likelihood of reaching new 2024 peaks soon, we need to see a sustained break above $1.27.

US Treasury bonds declined, causing yields to reach a one-month high after the US Supreme Court ruled that Donald Trump has some immunity from criminal charges related to efforts to overturn the 2020 election results. There is increasing speculation that a potential Trump presidency could lead to a steeper yield curve, as it might slow economic growth and accelerate inflation. The US dollar could experience a prolonged period of strength, as the inflationary risks associated with a Trump presidency may compel the Federal Reserve (Fed) to maintain higher interest rates for an extended period.

Even before last week's presidential debate, polling trends were unfavorable for the Democrats. Since mid-April, the PredictIt poll indicated just under a 60% probability of Biden winning the election. This probability has declined along with US macroeconomic data, with the economic surprise index hitting its lowest point since 2022. Consequently, with rising expectations of a Trump presidency, reinforced by the debate and its implications for expansionary fiscal policy, long-term Treasury notes and bonds have faced pressure, reducing the current inversion of the yield curve. The yield on the US 10-year Treasury note exceeded 4.45%, its highest level in approximately four weeks.

Meanwhile, data from the ISM indicated that the manufacturing sector underperformed in June, with lower-than-expected results in headline reading, employment, and prices paid. This marked the third consecutive month of declining manufacturing activity and the weakest reading since February. Additionally, investors are positioning themselves ahead of the JOLTS job openings report, one of the Fed's preferred labor market indicators, and upcoming remarks from Fed Chair Jerome Powell in Sintra, which could bring hawkish central bank rhetoric back into focus.

The EUR began the first week of Q3 on a stronger note following an eventful weekend. The initial round of the French parliamentary election saw Le Pen’s far-right party in front of Macron’s centrist alliance, albeit with potentially fewer votes than expected. In early Asia trading hours, EUR/USD and EUR/CHF rose by 0.3% and 0.5%, respectively.  The two significant events influencing the EUR this week are the second round of French parliamentary voting on July 7 and the preliminary Eurozone inflation report on Tuesday.

With three days remaining until the UK general election, international investors seem optimistic about a smooth transition to one of the two traditional governing parties. This sentiment is positive for GBP, gilts, and local equities. Opinion polls in Britain indicate a crushing defeat for the governing Conservatives after 14 years in power. However, Labour’s shift to a more pro-business, centrist position and potentially closer ties with the European Union under their leadership could strengthen GBP as the weekend approaches.  Currently, GBP lacks directional momentum ahead of the election. GBP/USD is hovering below $1.27, while GBP/EUR has dipped under €1.18 for the first time in three weeks.

The first half of the year ended with US and Japanese equities near all-time highs, with political risks resurfacing. The USD marked its fourth consecutive weekly rise, as the first US presidential debate increased Trump’s winning odds to as high as 65%. This was positive for the USD, as a Trump victory could lead to inflationary pressures, prompting the Federal Reserve (Fed) to maintain higher interest rates for longer.

This week in the US, attention will be on the ISM PMIs for the manufacturing and service sectors (June) for signs of economic slowing. The main event will be Friday’s labour market report, with economists expecting a decrease in hiring from 272k to 185k. Additionally, the Fed minutes from the last FOMC meeting may provide insights into policymakers' rationale for revising the expected policy path from three cuts to one this year.