The long-term health of the credit and financial markets hangs in the balance. While the US bailout plan is debated in the nation’s capital, risk sentiment and the carry trade continue to fade.

- Risk Appetite And Carry Frozen As Financial Crisis Evolves While Congress Debates
- Would The Carry Trade Rebound Even If A US Bailout Is Agreed Upon?
- Where Financial Turmoil Ends, Recessions And Rate Cuts Begin

The long-term health of the credit and financial markets hangs in the balance; and while the US bailout plan is debated in the nation’s capital, risk sentiment and the carry trade continue to fade. Indeed, while market conditions may seem better than last week when the panic was freezing liquidity, traders’ patience is quickly wearing thin as global central banks are still forced to inject short-term liquidity and major banks are failing while the US government’s rescue plan is held up by politics. Since the initial relief found when Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke proposed their $700 billion bailout, the DailyFX Carry Trade Index has fallen back from its temporary highs. Through Friday, the index was 147 points of last week’s levels at 26,520. Suggesting the market has remained skeptical throughout the past two weeks, condition indicators skipped the relief reflected in price. The DailyFX Volatility Index has advanced back to 13 percent while risk reversals have tumbled to 6 month lows.

Market participants are hesitant to take a position on direction – especially when it involves a risk-leveraged carry trade. While there are options on the table to help lift the US financial markets out of its downward spiral, the outlook for risk appetite is bleak regardless of when the plan goes through and what details it may come with. In the short-term, the longer the bailout is delayed, the greater the risk that the market will deteriorate into another panic state and the higher the probability that the banking sector will suffer further bankruptcies (we have already seen Washington Mutual go under). However, even if an agreement is reached, the market will still need to evaluate whether or not the effort can truly right a global problem with credit conditions and investor sentiment. Should the funds made available to the Treasury and Fed be too little, they wouldn’t be able to draw enough of the toxic debt out of the market to prevent ongoing write downs. What’s more, looking beyond this crisis, even if the financial markets begin to function properly, there is still a global downturn in growth to deal with. The drop in interest rate and investor sentiment that would no doubt follow this cooling in activity merely casts the carry trade in a poor light regardless of the effort made in the next few days and weeks.

John Kicklighter a Currency Strategist at FXCM.