Stock Markets Recover, but Money Markets Remain Stressed on Failed Bailout, Euro Falls

Equity markets got off to a strong start to start the day's trade, with the US Dow Jones Industrials Average up over 200 points soon after the New York Stock Exchange open. Yet it remains clear that markets remain stressed as of late, with the US House of Representatives rejection of the Treasury bailout bill forcing deterioration in global credit markets. We see that overnight US dollar borrowing rates climbed to their highest levels in over seven years - emphasizing banks' unwillingness to lend to one another. Such developments likewise make it expensive for forex traders to sell US dollars, and forex rollover rates remain far from normal through the day's trade.

According to London Interbank Offered Rates, financial institutions are currently charging an average of 6.875 percent for overnight loans on the interbank markets - the worst levels in at least seven years. The net result is that borrowing costs in US dollars are actually above their European counterparts, and interbank traders are actually charging rollover spreads on EURUSD-long positions.

Clear money market difficulties have led theUS Federal Reserve to increase liquidity provided to open markets, extending up to a staggering $225 billion in 84-day credit to ease end-of-quarter funding constraints. Such actions reflects the Fed's belief that money market conditions continue strained despite its great efforts to relieve them, and it seems that central bankers are almost willing to take matters into their own hands if the US Treasury's bailout does not come to fruition.

Despite the Fed's efforts, money markets have since deteriorated and it is difficult to predict whether we can expect buy/sell rollover interest rate payments on forex positions to improve in the week ahead. As long as major financial institutions remain unwilling to lend to each other, forex market conditions may make for expensive rollover interest rate payments through even the most liquid of forex pairs.

Such financial market stress has likewise translated into elevated transaction costs in the EUR/USD currency pair itself. The difference between Bid/Ask rates in the Euro/US Dollar pair has actually worsened through overnight trading. EUR/USD spreads remain below the extremely adverse levels seen following the Lehman Brothers bankruptcy filing, but it nonetheless remains clear that markets are far from normal. The chart below shows Bid/Ask spreads available in FXCM retail trading accounts through 2008. Since FXCM uses prices provided directly by the world's major institutions' currency dealing desks, this represents accurate picture of spreads available in interbank markets. FXCM markups are accounted for in the below spreads.

What's Next for the Forex Trader?

Increased financial market indecision makes it difficult to predict what may happen next, and sharp gains in volatility expectations reflect that uncertainty. After falling sharply through the past week of trade, implied volatilities on EURUSD 1-week forex options have once again jumped through recent developments - surging to all-time highs.

Such a jump likewise coincides with a similar return to risk aversion and a rally in the low-yielding Japanese Yen. If we see similar deterioration through near-term trading, we could easily see Japanese Yen continue to rally through the near term. Such rallies may be especially pronounced against the similarly risk-sensitive British Pound.

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