Risk appetite strengthened strongly on Thursday with reduced fears surrounding the global contagion risks from Evergrande.

Risk appetite strengthened strongly on Thursday with reduced fears surrounding the global contagion risks from Evergrande. European and US equities posted strong gains as international risk conditions dominated.

Asian equities were, however, more cautious on Friday amid underlying uncertainty. US bond yields strengthened with the 10-year yield at 11-week highs near 1.45%.

The dollar retreated against European currencies, but higher yields provided some US support. The yen weakened sharply amid gains in equities and higher global yields. EUR/USD edged higher towards 1.1750 before stalling. Sterling posted sharp gains after the Bank of England edged closer to raising interest rates. Commodity currencies secured strong gains on robust risk appetite before stalling on Friday.

The flash Euro-zone PMI manufacturing index declined to a 7-month low of 58.7 for September from 61.4 the previous month and below consensus forecasts of 60.3.

The services-sector index also weakened to a 4-month 56.3 from 59.0 and below market expectations of 58.5 while the composite PMI composite output index retreated to a 5-month low of 56.1 from 59.0. The German PMI data was also significantly below market expectations.

The data indicated that demand had peaked while there were still crucial difficulties surrounding supply chains while there was further upward pressure on costs and selling prices increasing at the third-highest rate on record. The Euro held steady despite the disappointing data with the dollar unable to make headway.

The flash US PMI manufacturing index edged lower to a 5-month low of 60.5 for September from 61.1 and below consensus forecasts of 61.5 while the services-sector index dipped to a 14-month low of 54.4 from 55.1 and below expectations of 55.0. The overall composite output index dipped to a 12-month low of 54.5.

There were further important supply-side difficulties which restrained activity and contributed to a sharp increase in unfilled orders.

Overall, the dollar continued to lose ground despite the more hawkish Fed rhetoric with the US currency losing defensive demand as risk appetite strengthened.

In this environment, the EUR/USD advanced to near 1.1750 before consolidating around 1.1740 on Friday as higher yields helped curb potential dollar selling pressure.

Risk appetite dipped briefly ahead of the New York open following reports that China had asked local governments to prepare for the eventual collapse of Evergrande, but there was only a brief blip lower in equities. Bank of England Woods stated that he was cautiously optimistic that China will avoid global contagion.

US initial jobless claims increased to 351,000 in the latest week from a revised 335,000 previously and above consensus forecasts of 320,000, while continuing claims increased to 2.85mn from 2.71mn previously. Overall bond yields edged higher which supported the US currency.

Wall Street equities posted strong gains and there was a notable dip in defensive yen demand as USD/JPY moved above the 110.00 level.

Japan’s PMI manufacturing index retreated to an 8-month low of 51.2 from 52.7 previously, while the services sector remained in contraction.

There was still uncertainty surrounding Evergrande’s bond payment, but reduced fears of global contagion. Japanese equities posted strong gains as the market re-opened, while Asian markets overall were mixed.  US yields continued to move higher and USD/JPY posted net gains to 6-week highs around 110.50 with EUR/JPY around 129.70.

According to flash data, the UK PMI manufacturing index declined to a 7-month low of 56.3 for September from 60.3 previously and below consensus forecasts of 59.0.

The services-sector index also declined to a 7-month low of 54.6 from 55.0 previously and slightly below market expectations. Business confidence retreated to an 8-month low while there was further strong upward pressure on costs and prices with selling prices increased at a record high.

The Bank of England held interest rates at 0.1% following the latest policy meeting, in line with consensus forecasts. There was a 7-2 vote for maintaining the bond-purchase programme at £875bn as Ramsden joined Saunders in calling for a reduction in purchases to £840bn.

The bank cut near-term GDP growth estimates, but there was slightly reduced confidence that higher inflation would be transitory and the MPC warned that inflation could remain above 4% until at least the second quarter of 2022. In this environment, the case for raising interest rates had strengthened to some extent even though there was a high degree of uncertainty. Money markets moved to price in an earlier interest rate increase around February next year which triggered Sterling gains.

Yield spreads over bunds increased to the highest level for six months and GBP/EUR rallied to 1.1710 while GBP/USD advanced strongly to near 1.3750. Sterling held steady on Friday as robust risk conditions underpinned the UK currency, but consumer confidence dipped sharply, maintaining recovery concerns with GBP/USD around 1.3720.

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