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US Government Impasse over Treasury Bailout Boosts Volatility, but Forex Markets Stable
Tuesday, 23 September 2008 23:00:00 GMT  |  David Rodriguez, Quantitative Analyst
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Forex market volatility has unexpectedly gained on the day, with increased uncertainty surrounding US Treasury plans to purchase distressed assets from increasingly fragile credit markets leading to similar uncertainty in the US dollar against major forex counterparts. Yet we see that key forex bid/ask spreads remain stable, and the immensely liquid FX market seems willing to cope with the risk of further fallout from broader financial instability.

News that the Treasury planned to buy illiquid debt instruments initially led to clear improvements in broader liquidity in credit markets, but the US legislative impasse over the proposed bailout threatens to undo recent improvements in financial markets. We see that our DailyFX 1-week volatility index has once again traded near its highest levels since the Asian Financial Crisis and failure of Long Term Capital Management, but it is important to note that this has not translated into lesser liquidity out of major forex pairs.

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What Does it Mean for the Forex Trader?

If today’s price action in forex options is any indication, markets could be gearing up for sharp intraday volatility across traded instruments. A flare-up in market tensions may be enough to initiate a renewed sell-off in carry trade pairs—leaving the Japanese Yen significantly higher while the high-yielding Australian and New Zealand dollars fall. We will track forex and financial markets here on DailyFX.com and keep traders updated on new developments in credit and currency trading. Yet it serves to note that forex bid/ask spreads remain far-improved from levels seen last week. As one of the most liquidly traded markets in the world, currencies are typically the last shoe to drop. If we see bid/ask spreads and overnight interest rates in forex trading worsen, then that is very clear indication that financial market conditions have deteriorated.

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Written by David Rodríguez, Quantitative Analyst for DailyFX.com

To contact the author of this report, e-mail drodriguez@dailyfx.com

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