Bank of England Governor Bailey stated that the rate of recovery had slowed over recent months and that slowdown is continuing.

Risk appetite held steady on Monday with markets continuing to monitor Chinese developments while energy markets had an important impact. There was choppy trading in Treasuries with a net increase in US yields to 3-month highs.

Wall Street equities posted net losses amid concerns over higher yields and upward pressure on costs. Asian markets were mixed with Chinese developments monitored very closely while US futures edged lower.

The dollar overall was unable to gain significant traction, but with support from yields and USD/JPY posted net gains to 12-week highs. EUR/USD settled just below 1.1700 amid a lack of Euro support. Sterling was underpinned by near-term yields despite unease over cost and energy pressures.

Commodity currencies were resilient and posted net gains as risk appetite held steady. Oil prices continued to gain ground amid expectations of a tight market with Brent at fresh 35-month highs.

The German Bundesbank commented that inflation was likely to peak between 4-5% by year end and could stay above 2% until at least mid-2022. ECB President Lagarde stated the bank’s baseline scenario is still that inflation stays below 2% over the medium term and that the inflation upswing is largely temporary.

The comments maintained expectations that the ECB would continue to pursue a very accommodative monetary policy, limiting Euro support.

There was further speculation that the process of forming a government could take months while SPD leader Scholz stated that a new government would be formed by Christmas. EUR/USD dipped lower to test support below 1.1700, although narrow ranges prevailed.

Chicago Fed President Evans stated that the threshold for tapering bond purchases is likely to be met soon if the labour market continues to strengthen. He added that a low unemployment rate does not necessitate a change in the policy rate if inflation has not reached unacceptably high levels. He added that with inflation still struggling to hit 2%, the jobless rate might decline to 3.5%. He expects one interest rate increase in 2023 and a gentle incline after that.

The dollar dipped lower following the comments, but selling pressure was limited and EUR/USD continued to test support below 1.1700.

San Francisco Fed President Williams reiterated that tapering may soon be warranted, but the criteria for an increase in interest rates are still a long way off.

Governor Brainard commented that employment was a bit short of the bar for tapering, but might meet it soon while she was vigilant for signs that the current high inflation rates might increase inflation expectations. The main take away from Fed officials was the insistence that an interest rate hike was a long way off which curbed potential dollar support. Commodity currencies posted limited gains on Tuesday, but EUR/USD was held just below 1.1700 on yield grounds.

US durable goods orders increased 1.8% for August from 0.5% previously and above consensus forecasts of 0.7%. Underlying orders declined 0.2% on the month, below market expectations of a 0.5% increase. There was choppy trading in Treasuries around the New York open with the 10-year yield increasing to 1.52% before a dip back below 1.48% and USD/JPY was unable to hold above the 111.00 level.

Markets continued to monitor the US congressional budget negotiations amid an October 1st deadline to avoid a Federal government shutdown.

Equities were held in relatively narrow ranges during the day with the yen unable to gain sustained support as USD/JPY consolidated just below 111.00.

Chinese industrial profits increased 10.1% in the year to August from 16.4% previously and Chinese equities posted net gains, although overall trends in Asia were mixed.  US bond yields edged higher again and USD/JPY strengthened to 12-week highs near 111.30 with EUR/JPY just above 130.00.

Although there were further important concerns over the economic outlook, currency markets also noted that other major economies were facing problems surrounding soaring energy prices. Sterling posted net gains in early Europe on Monday and there was also underlying support on yield grounds which provided a significant element of protection.

Bank of England Governor Bailey stated that the rate of recovery had slowed over recent months and that slowdown is continuing. He was still optimistic that most of the increase in inflation is transitory and estimated that the underlying rate of growth in earnings is around 4%. He did, however, note the importance of inflation expectations and insisted that the bank will keep a very watch on developments. He also commented that interest rates could be increased before the end of the asset-purchase programme which maintained speculation that rates could be increased this year.

Despite the caveats, GBP/USD traded near 1.3700 on Tuesday as underlying expectations that interest rates could increase this year underpinned the UK currency.

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