US yields edged higher amid the increase in US inflation expectations.

Risk appetite initially held firm before fading significantly later in New York as markets fretted over inflation trends. US yields edged higher amid the increase in US inflation expectations.

Wall Street equities posted sharp losses with significant selling in the tech sector. Asian equity markets overall also posted losses.

The dollar remained vulnerable on expectations of low interest rates, but recovered from fresh 10-week lows. EUR/USD hit selling above 1.2150. Sterling posted strong gains on recovery optimism and an easing of political fears and GBP/USD peaked at 10-week highs above 1.4150.

Commodity currencies failed to hold best levels as risk appetite dipped, but posted net gains. USD/CAD did post fresh 44-month lows.

The Euro-zone Sentix investor confidence index strengthened to 21.0 for May from 13.1 previously. This was well above consensus forecasts of 21.0 and the highest reading since March 2018 as investors took an optimistic stance towards the recovery outlook. The data maintained underlying confidence in the Euro, although dollar trends tended to dominate. US currency sentiment remained notably weaker following Fridays jobs data, especially given the increase in unemployment, with EUR/USD peaking above 1.2150.

There were stronger market expectations that the Federal Reserve would maintain very low interest rates for even longer in an attempt to foster maximum employment.

Chicago Fed President Evans stated that last week’s jobs numbers were definitely surprising, but expects that it will be a one-off. He noted that he would not be concerned with a 2.5% inflation rate if it is consistent with a 2.0% rate over time. He added that attention would need to be paid to wages and whether this would lead to sustainable inflation over the medium term. In this context, Evans stated that he did not expect that it would with an easing of pressures once bottlenecks are worked out.

Dallas Fed President Kaplan stated that he still expected strong jobs growth this year and continued to push for a tapering of bond purchases next year while San Francisco head Daly reiterated that it was not yet time to talk about a tapering of bond purchases.

Late in the European session, the dollar gained some protection from weaker risk appetite with a tentative recovery from fresh 10-week lows. The US currency was still struggling to gain sustained support, especially with very negative real interest rates and EUR/USD traded around 1.2140 on Tuesday.

The dollar and yen were both broadly out of favour during the day which limited the potential for major moves with the dollar held in narrow ranges.

Markets continued to monitor underlying inflation trends within the economy with the latest inflation release due on Wednesday. There were further concerns over upward pressure on wage rates after the 0.7% increase in hourly earnings for April. The latest New York inflation survey recorded an increase in 1-year expectations to an 8-year high of 3.4% from 3.2%. There was also a further jump in inflation expectations with the breakeven rates for US inflation protected Treasuries (TIPS) increasing to above 2.7%, the highest reading since April 2011. Markets will monitor the bond auctions this week with markets fretting over underlying inflation risks.

Inflation concerns were an important element triggering sharp selling on Wall Street equities. Chinese producer prices increased 6.8% over the year, the highest rate for over 3 years, reinforcing inflation concerns. Equity futures retreated further in Asia, although the yen and dollar remained vulnerable with USD/JPY around 108.85.

The Halifax reported that house prices increased 1.4% for April after a 1.1% increase previously with the annual increase at 8.2% from 6.5% previously. This was the strongest reading since August 2016, reinforcing evidence of strength in the housing sector.

The government confirmed that the UK coronavirus alert level had been reduced to 3 from 4 previously due to reduced transmission and it also confirmed that the further easing of restrictions would take place next week in England. In particular, there will be a re-opening of indoor hospitality which should underpin business and consumer confidence. In this context, there was further optimism that the UK economy would stage a strong short-term recovery.

Although the SNP won a further term in the Scottish election, there were expectations that the short-term risk of a second referendum remained low amid a pandemic focus. GBP/USD moved sharply higher to 10-week highs near 1.4150 while GBP/EUR rallied to 5-week highs above the 1.1635 level.

The latest Barclays data recorded an overall increase in household spending of 0.4% in the year to April despite the slump in travel spending. The Pound was hampered to some extent by weaker risk conditions with a GBP/USD retreat to near 1.4120.

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