Thursday, April 30, 2009

Risk appetite is back, maybe

One of the key issues followed by currency traders is the level of risk appetite in the market. Risk appetite goes up and the money flows into emerging market carry. Risk appetite goes down and the money more back into safe havens. The story makes sense and has served traders well but there seems to be growing increase in the capital flow sensitivity.

The risk appetite sensitivity has moved from looking at credit spread risk curves and volatility to viewing emerging market currency and debt as a substitute for equity, a high beta stock. The market has now moved to using equity returns as the measure of risk appetite. So we have events like today when there is a huge jump in Korean won based on the spike in equities and some positive news in Japan. The assumption that there is a strong correlation between a Japan recovery and a similar surge in Korea.

Carry used to be for buy and hold investors who wanted to creates gains in currency trading. Carry may be back but for these who are nimble traders.

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