Forex market conditions deteriorated overnight, as the largest bank failure in US history took its toll on broader financial markets. The Japanese yen quickly rallied on the financial market distress, and the JPY would stand to strengthen further if conditions do not improve through upcoming trade.

Washington Mutual bank, the nation’s largest savings and loan institution, was seized by the US Office of Thrift Supervision and most of it was quickly sold to JPMorgan Chase. Its unusually swift mid-week seizure ends a long saga for the beleaguered financial behemoth, but it likewise renewed market fears of systemic risk in broader credit markets.

Renewed financial market difficulty could be felt through forex trading markets, as a drop in liquidity led typically narrow bid/ask spreads on the euro/US dollar currency pair to widen considerably. As one of the most liquidly traded instruments in the world, the EUR/USD is often the last place that one would see sharp drops in liquidity. Indeed, the fact that most interbank forex trades are settled within a mere five hours means that there is very little counterparty risk and broader concerns over financial solvency seldom affect on the heavily-traded currency pair. Thus a sharp deterioration in EUR/USD spreads underlines the fact that traded markets are distressed.

Increased financial market indecision makes it difficult to predict what may happen next, and sharp gains in volatility expectations reflect that uncertainty. After falling sharply through the past week of trade, implied volatilities on EUR/USD 1-week forex options have once again jumped through recent developments.

Such a jump likewise coincides with a similar return to risk aversion and a rally in the low-yielding Japanese yen. If we see similar deterioration through near-term trading, we could easily see Japanese yen continue to rally through the near term.

David Rodriguez is a Currency Analyst at FXCM.