Both the Japanese Yen and Euro were in the spotlight on Friday. Both are being affected by the same news but both are moving in opposite directions versus the Dollar.

The central theme driving investors out of the Euro is risk aversion. Speculation that the global economic recovery is stalling is leading investors to shun higher priced assets and move to lower-yielding currencies. This speculation is encouraging the selling of the Euro while triggering buying interest in the U.S. Dollar and the Japanese Yen. This was apparent Friday when a drop in U.S. consumer sentiment weakened the stock market and the Euro while pushing up the Yen.

Heavy selling pressure in the global equity markets is leading investors to believe that an economic recovery in 2009 and early 2010 is highly unlikely. This is encouraging longer-term traders to reallocate money into the U.S. Dollar and eventually into the U.S. Treasury markets. Furthermore, Japanese Yen investors are pulling their money out of global equity markets and bringing their money back home despite receiving literally no return on capital. This move by the Japanese investor is a clear sign that return of capital is more important than return on capital at this time.

Declining economic data, led by the news that China's economy may not be as rosy as investors thought earlier in the year, is leading to speculation that the global economic recovery is stalling and that investors will be more defensive in their investment strategy going forward.

Earlier in the week the International Monetary Fund said the global economy will shrink 1.4 percent this year before expanding by 2.5 percent next year. While next year's forecast seems a little too optimistic, traders are focusing on the current economic environment and reacting as if the 1.4 percent contraction this year may be difficult to obtain. The surge to the upside in the Japanese Yen this week is a strong indication that a defensive strategy is the best strategy.

Besides the faltering global economic picture, Euro traders are feeling pressure from reports that the International Monetary Fund is actively discussing aid programs with distressed Eastern European nations. The problem with toxic assets in the Eastern European banks has been swept aside since February but has now risen to the spotlight again. With these problems lingering investors have become more risk averse toward the Euro. This is leading to selling pressure on the Euro as traders are seeking safety in the U.S. Dollar and the Japanese Yen.

The issue developing in Europe is whether the IMF will ask the European Central Bank to help provide aid to the distressed Eastern European banks and governments. This is helping to put pressure on the Euro. This news should not come as a surprise to the ECB which can be accused of dodging the toxic asset problem for months. Its general feeling is that these Eastern European countries created their own problems by trying to expand too aggressively and taking on more debt than they could handle.

The Japanese government is also becoming concerned about the rapid rise in the Japanese Yen. Despite being the beneficiary of this risk-averse driven environment, the Japanese do not want to see the Yen appreciate too rapidly. Concerns are being raised that a higher priced Yen will hurt both exports and corporate profits. This may lead to speculation that the Bank of Japan may once again begin talking about an intervention.

Technically, the Japanese Yen rally has been triggered by momentum buying through technical resistance levels. While the current upside momentum is not expected to continue at its current pace, the former resistance levels are expected to act as support. The EUR USD, on the other hand, has been drifting lower without much downside momentum. Traders seem to be complacent with the current trading action, with many analysts calling this market range bound or sideways. This complacency is exactly what could trigger a volatile market this coming week. Often the more complacent traders become the greater the chance of volatility returning.

In addition to the falling Euro, traders should note that the selling pressure is also beginning to take its toll on other higher-yielding currencies such as the Australian Dollar and New Zealand Dollar.

In summary, the global currency markets are currently in the midst of a risk-averse environment. As long as the global economy continues to show signs of faltering and equity markets continue to retreat, look for investors to shun the possible appreciation in higher yielding currencies like the Euro for the safety of the lower-yielding currencies like the U.S. Dollar and the Japanese Yen.

Technical signs are beginning to indicate that there is more downside expected in global equity markets. Earnings surprises could trigger volatile days. Look for the risk aversion trend to continue with more downside expected in the Euro and a continuation of the rally in the Yen unless the Bank of Japan decides otherwise.

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