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In the period after the Federal Reserve statement on Tuesday until the end of Asian trading on Thursday, risk aversion eased with a significant return of confidence in high-yield assets and rising stock markets. The yen and Swiss franc also encountered fresh selling pressure as carry trade activity resumed.

Credit fears have now returned with the announcement that withdrawals had been suspended on three BNP Paribas funds. There have also been rumours of difficulties at German bank WestLB, which have been denied.

In addition, US and European money market rates have tightened with a spike in interest rates and rumours of an ECB meeting to discuss liquidity difficulties.

Markets are still in the very dangerous northern hemisphere Summer period when underlying liquidity is running at reduced levels which increases the threat of erratic and volatile trading. Overall it is unlikely that markets will settle over the next two weeks at least.

Source: Investica

The market’s pretty volatile today with EUR and GBP doing some seesaw starting from a plummet.

Coming at a time when Fed Chairman Bernanke is facing is first potential crisis, it will be very interesting to watch The Fed’s policy play out through all of this. I would not expect to see a change in the inflation bias, although markets will be looking for any sign of change in The Fed’s opinion regarding the housing situation and its potential to hinder growth going forward. As Bernanke clearly stated during his testimony last month, the situation is viewed as being “contained”.

Former Fed Chairman Allan Greenspan would have been talking about easing by this time and it’s fairly well established that Greenspan’s over-easing of policy helped cause the housing/credit bubble to begin with. Ben Bernanke operates in a very different way then his predecessor. Greenspan was much more of an intiutive, seat-of-the-pants type, while Bernanke’s academic and research background leads him to rely on history, models, projections and mathematics. If Bernanke were to paraphrase the former chairman, he might use the phrase “Immoderate Indulgence” to describe what had existed before all this blew up.

In my opinion, Bernanke will not be easing policy or changing his statement based on what he likely sees as a necessary adjustment to the “immoderate indulgence” despite the fact that people are going to be hurt in the process, because it’s likely that the “biting of the bullet” that will occur now is probably the best chance for assuring the long term health and stability of the U.S economy. Economic leaders from Central Banks, the IMF and the BIS have long warned against the excesses they saw in the fixed income markets, making the current situation of the “chickens coming home to roost” variety in their view.

That being said, we trade from the information at hand so a careful observation of the statement will be crucial to anticipating future market trends.

If the Fed were to allude to the possibility of the present situation being a worse drag on the GDP then previously estimated (perhaps by saying that the risks to their growth estimate had increased), markets would feel supported and would interpet the remarks as indicating The Fed is that much closer to a rate cut, or at least to a more neutral bias. While the underlying problems would still exist, markets would see a light at the end of the tunnel and that might be enough to turn things around; equities, carry trades and risk acceptance would again be the order of the day. What that would also do is further weaken the dollar, due to the combination of renewed risk appetite in carry trades and the likely fall of bond yeilds.

They did this at the March 21st meeting when they alluded to the increased risks to their growth assessment. The DOW took off from there, eventually reaching 14,000 while GBP/JPY went from 231.5 to a closing high of 250 on July 17, in spite of the fact that the inflation bias was retained. As a matter of fact the dollar has done nothing but weaken during the entire time the inflation bias has been in affect, to say nothing about how high the DOW and carry trade positions have gone.

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Source: Forexfactory, NewsTraderFX

I like this guy’s insights. A fundamental trader?