Turmoil in the FX market - watch the forward points

Even markets that are not sensitive to credit issues like foreign exchange are seeing significant spill-overs. The largest most liquid market is controlled through margin of credit or bank lines for trading. If some of the counter-parties go bankrupt like Lehman, there will be an impact in FX liquidity as traders find new bank lines and close positions. If you have a net credit with a forward trade done with a bad counter-party, you may be out the net credit from unrealized profits.

Additionally position traders have been facing significant risks in the forward market with forward points jumping in ways which have not been seen since the early 1990's. While spot prices have been in some cases relatively stable, forward volatility has spiked as traders making these markets are unclear where fund rates will be for short-term maturities. We have seen inversion of forward curves over the course of 2-3 days,significant moves in rates under one to three months, and a market that is jumping in the course of minutes where the spot rates are not seeing a change. These markets are priced off of cash lending rates, so it is not surprising that this would happen but a simple look at spot will not show the angst in the forward points. This is another reason for the coordination with other central banks. Seizing up in the FX market will be an unnecessary contagion to this crisis.