Financial Market Risk Re-evaluation

Recent developments in world financial markets suggest an increase in international volatility.  As the carry trade thrives on financial stability and an increasing appetite for risk, an upward re-evaluation of that risk could slow down carry trades in the forex market.  The most prominent situation is the one regarding US dollar-denominated assets.  Recent economic data has actually surprised to the upside.  And this week’s housing data should be fairly positive as well.  But the dollar sank like a stone over the weekend.

The hedge fund shutdown at Bear Sterns has ignited fears of an industry-wide re-pricing of bonds that would prove catastrophic to financial institutions all over the country.  When you add to that the growing volatility in the US equity markets (alternating days of gains and losses), traders have to view the currency market with a little more doubt.  Yield is really all they care about, and most signs point to the Fed making a non-move with regard to interest rates.  If the US market continues in this vein, the pound (which just broke resistance at 2.000) and the euro should clean up against the dollar this week.

International volatility does not end at our shores.  Risk has also reached the New Zealand dollar.  Chances are likely that the RBNZ intervened in the forex market again late last Friday.  When the Kiwi falls 60 points against the dollar in that short a time, something fishy is up.  So far, traders have been willing to weather these drops, and the currency continues to rise.  The central bank may be running out of money, but its resolve has not weakened in the face of what it feels it an overvalued currency.

Faced with this kind of data, the risk appetite of forex traders is being tested.  The Japanese yen, which is ridiculously undervalued, actually rose against both the US dollar and the euro in weekend trading.  Traders are cashing in on their carry trades, spurred by a report from the Bank of International Settlements warning against the one-way bet against the Japanese currency.  Even the Chinese central bank is calling for higher interest rates.  In these days, the specter of 1998 looms large, but even that may only prove to be a temporary brake on the risk appetite of currency traders.