Forex market volatility has unexpectedly gained on the day, with increased uncertainty surrounding US Treasury plans to purchase distressed assets from increasingly fragile credit markets leading to similar uncertainty in the US dollar against major forex counterparts.

News that the Treasury planned to buy illiquid debt instruments initially led to clear improvements in broader liquidity in credit and forex markets alike, but the US legislative impasse over the proposed bailout threatens to undo recent improvements in financial markets. Indeed, we see that our DailyFX 1-week volatility index has once again traded near its highest levels since the Asian Financial Crisis and failure of Long Term Capital Management.

Though markets have hardly escaped difficult conditions altogether, we previously saw credit market tensions ease and broader liquidity in financial markets improve on the announcement of US Treasury plans. US Dollar Overnight London Interbank Offered Rates, or the rates charged for overnight lending between banks, have fallen over 300 basis points in a span of mere days. Though these numbers remain notably above the equivalent risk-free rates, we clearly saw signs of improvement in financial markets.

If today’s price action in forex options is any indication, markets are once again gearing up for sharp intraday volatility across traded instruments. A flare-up in market tensions may be enough to initiate a renewed sell-off in carry trade pairs—leaving the Japanese Yen significantly higher while the high-yielding Australian and New Zealand dollars fall. We will track forex and financial markets here on DailyFX.com and keep traders updated on new developments in credit and currency trading.

David Rodriguez is a Currency Analyst at FXCM.