Risk appetite deteriorated sharply on Monday as fears over political and economic risks increased.

Risk appetite deteriorated sharply on Monday as fears over political and economic risks increased, especially with concerns over global coronavirus developments. Wall Street equities declined sharply on earnings fears with European equities weakening sharply, although US losses were pared in late trading.

The dollar gained defensive support amid weaker risk conditions with the US currency overall at 6-week highs. EUR/USD dipped below 1.1750 before stabilising to some extent. Sterling was hurt by domestic economic concerns, political unease and risk vulnerability.

Commodity currencies declined sharply amid fears over the global economic rebound. Oil prices were also hit by weak risk appetite as demand fears continued. The stronger dollar undermined precious metals amid position liquidation.

In its latest monthly report, the German Bundesbank stated that the German economic recovery may lose some more momentum heading into the year-end. Industrial orders were likely to slow with caution over exports evident while the services sector remained constrained by coronavirus containment measures.

ECB President Lagarde stated that the recovery remains very uncertain, uneven and incomplete. In this context, the uncertain environment required very careful assessment, including developments in the exchange rate. The bank will certainly be relieved if the Euro strength fades, although losses in the face of a slide in risk appetite will do little for economic confidence. She also stated that the central bank has room to add to stimulus and can adapt its toolkit if the economy needs more help.

The Chicago Federal Reserve national activity index declined to 0.79 for August from 2.54 for July.

There were significant positive contributions from industrial production and employment, although there was a small negative contribution from the consumption and housing indicators.

Risk conditions dominated during the day with the dollar gaining strong support and as equity markets declined sharply. Commodity currencies were an important casualty and EUR/USD retreated to 5-week lows below 1.1750. The dollar overall strengthened to six-week highs before correcting late in the US session.

In comments released before a Congressional appearance on Tuesday, Fed Chair Powell reiterated that the central bank will do what it can for as long as it takes. The path ahead for the economy remained highly uncertain even though many indicators show marked improvement. The US currency faded slightly from its stronger levels as equity markets attempted to stabilise, although the bounce in commodity currencies was weak with EUR/USD trading around 1.1750 on Tuesday.

The dollar remained under pressure ahead of the New York open on Monday and USD/JPY retreated further to 6-month lows at 104.00 as risk aversion continued to underpin the Japanese currency. Risk appetite deteriorated sharply as Wall Street equities registered sharp losses and the Japanese currency secured strong support.

There were further concerns over US-China relations with reports that China was debating whether to release a blacklist of US companies. There were also reports that the TikTok Oracle deal would not be approved in China and underlying political uncertainty remained a key element.

Budget developments will also be monitored closely, although there were no major developments. New York Fed President Williams and Atlanta head Bostic both called for further fiscal support from Congress. In contrast, St Louis Fed President Bullard commented that the Fed had already delivered enough fiscal support to sustain economic momentum. USD/JPY secured support at 104.00 and recovered to 104.80 amid wider gains, although the yen still secured net gains on the main crosses.

The dollar was unable to sustain the advance and USD/JPY retreated to the 104.50 area as the yen held a firm tone on the crosses amid weak underlying capital outflows. Japanese markets remained closed for a holiday, although markets remained wary over the risk of verbal intervention from the Japanese Finance Ministry.

Sterling was undermined by the sharp slide in risk appetite during Monday as global equity markets declined and confidence in both the domestic and global economic recovery slipped. Warnings from key UK health officials over the near-term threat posed by coronavirus was also a negative element for the UK currency, especially with expectations that there would be further restrictions on national activity within the next few days.

GBP/USD declined to lows below 1.2800 while GBP/EUR dipped towards 1.0874. There was a further tightening of local coronavirus restrictions and the UK government will also announce further measures this week including curfews for pubs.

There were further concerns that the underlying recovery will stall which undermined sentiment. Markets will also continue to monitor political developments with further debate over the Internal Market Bill. Sentiment remained fragile with GBP/USD just below 1.2800 as risk conditions remained fragile.

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