Forex Trading

• Carry Diverges From Risk Appetite: What are the Risks to a Market Recovery?
• Outlook for Yields Starting Rising To Levels That May Compensate for Lingering Risk
• Will G8 Finance Ministers Discuss Spark Volatility?

Risk appetite in most regions of the financial market is still actively suppressed by skepticism over early growth warnings and concern surrounding the eventual unwinding of government support from a still fragile global economy. However, shirking the caution seen most prominently in the equities market, carry interest have surged this past week. Looking at the Carry Trade Index, a sharp 430 point rally this past week has pushed the gauge to retest the 10-month high set early last week. Why the divergence? The answer lies in the market conditions numbers. The DailyFX Volatility Index has shown a quick retreat from the aggressive rise in sentiment that transpired over the previous four weeks. This is in line with the deflated fear indicators for the other traditional asset classes (the VIX, junk bond spreads, credit default swaps, etc). More interesting, however, is the improvement in the other side of the traditional risk/reward balance in the market. While market sentiment is still the primary source of strength for most investments; there have been a few key changes to yields over this past week to support the traditional carry trade basket. Most notably, the RBNZ announced it would hold its benchmark unchanged at 2.50 percent and forecasts for RBA interest turned decidedly hawkish in the span of a few days. Is this shift in returns indicative of the larger currency market? No. However, when sentiment is balanced like it has been over the past few months, a factor like this can make all the difference in the world.

Sudden shifts in yield speculation or sentiment like we have seen this past week are critical for swing traders; but for carry interests, they can be a dangerous distraction. A stability in risk and return is essential for supporting the longer-term strategy. And, considering the evolution of fundamentals this past week, there is little reason to believe that optimism is on the verge of a sudden and complete return. To be sure, there were a few positive events to take account of. The two highest yielding, liquid currencies reported a positive shift in their respective rate forecasts. What’s more, the outlook for an economic recovery was furthered by a far smaller-than-expected drop in US payrolls. However, these are still dull readings in an overwhelming gloom. There is a consensus among policy officials and market participants that current recession will hold over for the rest of the year and that even the eventual recovery will be drawn out and slow. In fact, the World Bank today downgraded its forecasts for activity through 2009 from a 1.7 percent contraction in March to 3.0 percent slump. In the meantime, there are plenty of factors that could derail a recovery. Sovereign debt ratings, ballooning budget deficits, struggling financial institutions, diminishing confidence in safe-haven assets and the government’s eventual withdraw of its financial aid are all big ticket issues. The mention of any one of these at this weekend’s G8 meeting could substantially alter sentiment.

Written by John Kicklighter, Currency Strategist
Article Source - Carry Diverges From Risk Appetite: What are the Risks to a Market Recovery?