Risk aversion is liable to remain higher in the short term, but a limited corrective retreat is realistic for the Japanese yen and Swiss franc in the near term.
There has been a further exodus away from carry trades over the past 24 hours. The Japanese yen and Swiss franc have continued to strengthen sharply with the yen strengthening to highs near 108.25 against the US currency while the Swiss franc strengthened to highs near 1.1110.
Investors have taken a more risk-averse stance at the beginning of 2008 with increased fears over the global economy. Although immediate liquidity issues have been addressed, there are further fears over the implications of an underlying tightening in credit conditions. The drop in global stock markets has also triggered a move to more defensive currencies, especially following the weak US PMI data on Wednesday.
Japanese markets remained closed on Thursday and the lack of retail participation will tend to underpin the yen with a reduced flow of funds overseas.
The attitude of Japanese investors will be watched very closely once Japanese markets re-open on Friday and a continued reluctance to invest overseas would tend to limit the potential for a rebound in carry trades. There is, however, the potential for at least a limited near-term correction.