Risk appetite was notably fragile on Monday with further global concerns over conditions in China.

Risk appetite was notably fragile on Monday with further global concerns over conditions in China. Wall Street equities declined sharply with the S&P 500 index posting a 1.7% retreat. US futures rallied on Tuesday with the Chinese holiday maintaining a high degree of uncertainty. US bond yields declined on the day, although moves were contained.

The dollar secured initial defensive demand but retreated from intra-day highs. EUR/USD found support close to 1.1700 and secured a limited net gain. Sterling was hurt by weaker risk conditions and energy-price concerns with 4-week GBP/USD lows below 1.3650 before a limited recovery.

Commodity currencies dipped sharply before attempting to correct as global risk conditions dominated. The Canadian dollar strengthened after the Liberal Party performed more strongly than expected to return as a minority government.

Overall risk conditions continued to dominate ahead of Monday’s New York open with equity markets coming under renewed pressure. The dollar gained a further element of defensive support amid deteriorating sentiment and commodity currencies weakened further. EUR/USD did, however, find support close to the 1.1700 level and gained an element of protection from a closing of carry trades funded through the single currency.

ECB council member Schnabel stated that premature policy tightening would be a bigger mistake than waiting, maintaining expectations that the central bank would maintain a very accommodative stance in the short term despite higher inflation.

The US NAHB housing index edged higher to 76 for September from 75 the previous month and slightly above consensus forecasts of 74 which helped maintain near-term confidence in the housing sector. There was, however a warning from a major housebuilder that supply shortages would lead to lower than expected sales.

There was some speculation that the Federal Reserve would draw back from more hawkish policy language, especially given reservations over developments in China and this curbed dollar demand to some extent. In this environment, EUR/USD edged higher to 1.1730 at the European close, but failed to make further headway. Tight ranges prevailed on Tuesday with EUR/USD around 1.1730 as the dollar retreated slightly and commodity currencies attempted to recover ground.

US Treasuries gained fresh support from risk aversion ahead of the New York open with further demand for liquid assets. The decline in US yields curbed potential dollar support and there was also renewed defensive demand for the yen. Given that the latest CFTC data recorded only a slight decline in short yen positions and there is still the potential for substantial position adjustment if fear dominates for an extended period.

The dollar faded from its best levels and USD/JPY weakened to near 109.50 as yen demand remained firm.

There were no expectations of significant policy changes by the Bank of Japan and the dollar remained under pressure around the Wall Street close.

There was further uncertainty over the US fiscal support package with further difficulties in getting legislation through congress.

Chinese markets remained closed on Tuesday, maintaining a high degree of uncertainty ahead of the re-opening on Wednesday. Expectations of further central bank liquidity injections helped soothe markets to some extent and US futures recovered ground, although Hong Kong stocks edged lower.

USD/JPY edged higher to just above 109.50 with EUR/JPY around 128.50 as Evergrande attempted to offer reassurance, but sentiment remained notably fragile with the potential for sharp moves across asset classes when Chinese markets re-open. Markets will be braced for choppy conditions in Asia on Wednesday.

Sterling remained on the defensive during Monday with the slide in global risk appetite having an important in curbing demand for the UK currency. There was an early GBP/USD dip below 1.3700 and it was unable to recover this level into the European close with losses to a 4-week trough below 1.3650.

There was an element of speculation that higher gas prices would undermine UK output and trigger a less hawkish Bank of England policy stance even though there will also be notable upward pressure on the inflation rate. GBP/EUR also posted losses to around 1.1640 as the Euro currency secured defensive support.

A tentative bounce in risk appetite helped underpin Sterling on Tuesday with a GBP/USD recovery to 1.3680 while the Euro held firm. Global risk conditions will tend to dominate during the day, but there will also be caution ahead of Thursday’s Bank of England policy announcement.

The latest UK government borrowing requirement was higher than expected at £19.8bn for August with Sterling sentiment remaining notably cautious.

Economic Calendar