Sentiment deteriorated further on Monday amid further fears over contagion from Evergrande with liquidity hurt by holidays in Japan and China.

Risk appetite deteriorated on Friday with underlying concerns over the Chinese outlook and specific fears over Evergrande. Sentiment deteriorated further on Monday amid further fears over contagion from Evergrande with liquidity hurt by holidays in Japan and China.

Wall Street equities posted significant losses with futures lower on Monday. Asian markets declined sharply on Monday with notable losses in Hong Kong. US bond yields were little changed despite reservations over the US outlook.

The dollar posted significant gains amid higher yields and defensive demand. EUR/USD dipped to 4-week lows near 1.1700. Sterling was hampered by the slide in risk appetite and unease over higher energy prices with GBP/USD sliding to 3-week lows near 1.3700. Commodity currencies dipped sharply amid the side in risk appetite.

The headline Euro-zone inflation rate was confirmed at 3.0% for September and the core rate at 1.6% with markets monitoring ECB rhetoric closely.

ECB council member Kazaks stated that the inflation outlook is likely to be revised higher, but still does not see the 2% target being reached sustainably over the medium term. Fellow member Makhlouf commented that fears over excessive inflation are overstated and current price pressures reflect transitory factors.

Latest opinion polls continued to indicate that the CDU/CSU centre-right alliance was lagging in opinion polls ahead of next week’s Federal election with 22% support, maintaining speculation that there could be a SPD/Green coalition after the election.

The US University of Michigan consumer confidence index recovered marginally to 71.0 for September from 70.3 previously, but slightly below consensus forecasts. There was a further small dip in the current conditions index, offset by a recovery in the expectations component which maintained some demand reservations.

The 1-year inflation expectations index edged higher to 4.7% from 4.6% while the 5-year rate was unchanged at 2.9%.

The dollar gained strong support later in the day as risk appetite dipped with sharp losses for commodity currencies and in this environment, EUR/USD dipped to lows near 1.1720. CFTC data recorded a small net increase in long Euro positions with a small net increase in the overall long dollar position for the week.

The dollar continued to secure defensive support on Monday with EUR/USD near 4-week lows around 1.1715 as commodity currencies continued to decline.

The Chinese central bank injected funds into the money market on Friday, but market unease over the Evergrande situation continued to unsettle risk appetite, especially with reports that Chinese commercial banks are making loss provisions with the company not expected to make a scheduled debt repayment this week.

US Treasuries lost ground in early US trading on Friday with the 10-year yield increasing to 2-month highs around 1.38%. Higher yields underpinned the dollar, but the yen gained defensive support from a slide in equities and the USD/JPY advance was held close to 110.00.

As far as the US is concerned, there was fresh speculation that the US fiscal stimulus package would be delayed and there were also further warnings from Treasury Secretary Yellen over the need to raise the US debt limit again to avoid catastrophe.

Asian developments had a more substantial market impact on Monday with further fears over the Evergrande situation amid fears that a collapse would trigger domestic and global contagion. Japanese and Chinese markets were closed for a holiday, although the Chinese central bank again added liquidity over the weekend. Risk appetite still dipped sharply as fear dominated. Weaker equity markets maintained an element of defensive yen demand with USD/JPY held just below the 110.00 level with EUR/JPY around 128.70.

Sterling was unable to make any headway in early Europe on Friday which confidence sapped by the weaker than expected retail sales data.

The UK 1-year inflation expectations increased to 2.7% in the latest survey from 2.4% previously while longer-term expectations increased to 3.0% from 2.7%.

Sterling was hampered by a weaker tone surrounding risk appetite, especially after the US open as the FTSE 100 index dipped below the 7,000 level. Overall, GBP/USD dipped to lows around 1.3730 with GBP/EUR posting limited losses to 1.1715 as risk conditions remained vulnerable into the New York close.

CFTC data recorded a sharp reversal with a net long non-commercial Sterling position of close to 5,000 contracts after a short position of over 24,000 the previous week. The positioning data will leave the currency vulnerable to significant losses if sentiment dips again.

Weaker risk appetite was important in undermining Sterling on Monday while market uncertainty over Bank of England policy and statement this week was heightened by the surge in energy prices which will hurt demand and put upward pressure on inflation. GBP/USD dipped to 3-week lows near 1.3700 with GBP/EUR weakened to 1.1715 amid vulnerable risk conditions.

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