Risk appetite recovered on Monday amid some speculation that markets had over-reacted to last week’s Fed statement.

Risk appetite recovered on Monday amid some speculation that markets had over-reacted to last week’s Fed statement. Wall Street equities posted significant gains on the day. US bond yields moved higher as equities moved higher. Global bourses posted gains with notable relief surrounding Japanese equities as the yen retreated.

The dollar corrected weaker following sharp gains last week, but with limited follow-through selling. EUR/USD moved back above 1.1900 before fading slightly in early Europe on Tuesday. Sterling posted net gains on stronger risk appetite and expectations of more hawkish Bank of England commentary.  Commodity currencies recovered ground, although caution remained in evidence.

The Euro was able to maintain a corrective stance in early Europe on Monday with the US dollar also correcting weaker after posting strong gains over the second half of last week. After finding support close to 1.1850, EUR/USD strengthened to highs around 1.1900.

The Chicago Fed national activity index came in at 0.29 for May and below expectations of 0.70 following a revised 0.09 decline for the previous month.

St Louis Fed President Bullard reiterated that the central bank needs to be ready for upside risks to inflation, although he added that the central bank needs to be ready to react on both sides and stay nimble with central bankers emphasising two-sided risks.

Dallas Fed President stated that the data has been much better than expected and the central bank is responding to that data.

New York Fed President Williams stated that there were risks to both sides of the Fed’s employment and inflation goals and the outlook is still uncertain, although he also noted that there are upside to risks which has been stronger than expected.

Markets will be monitoring US data very closely given the potential impact on Fed policy, although with no major releases due in the short term.

ECB President Lagarde stated that the outlook for the economy is brightening with the potential for stronger consumer demand and a faster than expected increase in consumer demand. She added, however, that policy tightening would be premature and pose a risk to the on-going recovery.

The dollar was unable to regain ground later in the day and EUR/USD settled above 1.1900 as commodity currencies also recovered.

The US currency stabilised on Tuesday with EUR/USD just below 1.1900 as the retreat in the US currency triggered further underlying short covering.

US Treasuries lost ground ahead of Monday’s New York open with bond yields moving higher. USD/JPY found support below the 110.00 level and strengthened to the 110.20 area as US yields advanced. The dollar was able to hold gains as the yen lost significant ground on the crosses amid strong gains in global equities.

Markets will monitor comments from Fed Chair Powell very closely on Tuesday. In prepared testimony to Congress, Powell stated that the central bank would do everything it can to support the economy for as long as it takes to complete a recovery, but also noted that inflation has increased.

US equity futures held firm in Asa on Tuesday and US yields edged higher with Asian bourses also staging a significant recovery. Defensive demand for the yen faded as equities posted gains and USD/JPY pushed towards 110.50 in early Europe while EUR/JPY traded just below 131.50.

GBP/USD was able to regain the 1.3800 level in early Europe on Monday which helped underpin confidence and there were significant gains ahead of the New York open, especially with the US dollar correcting weaker. Sterling also secured wider support as risk appetite attempted to stabilise with a GBP/USD move to 1.3880 while GBP/EUR also rallied as Sterling posted net gains on the major crosses.

Interest rate futures dipped sharply during the day amid speculation that the Bank of England would adjust its interest rate guidance at Thursday’s policy meeting. The increase in yields was a significant factor underpinning Sterling during the day. At the moment, futures markets are pricing in a 30 basis point rate hike by the end of 2022. Equities secured further gains after the Wall Street open which also helped underpin the currency.

GBP/USD pushed above 1.3900 with highs around 1.3935 after the European close with GBP/EUR rallying to near 0.8550. Risk conditions held firm on Tuesday, but Sterling was unable to extend gains and GBP/USD traded close to 1.1690 as the government borrowing data had little impact.

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