Forex market conditions in the Euro/US Dollar currency pair are much improved on the week, and a positive change in trading conditions for the euro suggests that broader financial markets may likewise recover. As one of the most liquidly traded instruments in the financial world, the EURUSD currency pair serves as an ideal barometer of broader financial market conditions and risk appetite. As such, our own forex trading indicators suggest that financial market conditions are not nearly as fragile as major news outlets would suggest.

According to the Bank of International Settlements, average daily trading volume in the Euro/US Dollar currency pair reached record-highs of $840 billion through 2007. Impressive trade volume translates into lower transaction costs in the EUR/USD and very narrow bid/ask spreads. Yet last week we saw typically narrow EUR/USD bid/ask spreads widen to their worst in at least 16 months—emphasizing that broader market fears spread to even the most liquidly traded instruments.

Widened spreads suggest that major banks and other financial entities were unwilling to take risk and feared that counterparties would fail—thereby defaulting on trades and forcing major dealing desk losses. Such counterparty fears are very unusual given that the majority of forex trades between major institutions are settled within a mere five hours. Yet perceived systemic risks across all banks and other trading institutions forced many forex market participants to limit their exposure to currency trading—leading to extreme illiquidity in even the Euro/US dollar currency pair.

More recently we see that bid/ask spreads in the Euro/US dollar have returned to approximately normal levels. It appears that financial market conditions are slowly improving, and fears about counterparty insolvency have receded. This goes contrary to what often sensationalist financial media outlets are reporting—spreading doom and gloom and fears that another major bank will fail in a matter of days. Of course, we can never rule this out, but recent improvements in forex market liquidity suggests that major financial institutions have somewhat regained confidence in overall market conditions.

The clear improvement in forex markets on the week gives us hope that we may continue to see broader financial market conditions stabilize. Yet we will clearly monitor new developments across global traded markets. A cursory look at expected volatility in the EUR/USD for the week ahead shows that traders are already scaling back expectations of sharp price moves, but it remains to be seen whether we can see conditions continue to improve given broader financial market indecision.

David Rodriguez is a Currency Analyst at FXCM.