More tremors in global financial markets, this time from the rather arcane field of ultra short term bond funds, sent carry trades lower as investors liquidated all risky positions indiscriminately sending EUR/JPY nearly 200 points lower while USDJ/PY approached the critical 116.50 level. Sentinel Management Group, a money market substitute fund that invested in the Fed funds market as well as very short term government and corporate securities, appealed to CFTC to allow it to halt redemptions after noting that markets were refusing to properly value its portfolio forcing it to assume significant losses in order to liquefy.

Unlike the recent problems of hedge funds that held toxic sub-prime securities, Sentinel traded only in the shortest and most secure debt instruments intended to mimic the liquidity and safety of a money market fund. The fund's website even claimed that its clients never lost money. Yet the fact that even players such as Sentinel are having massive liquidity problems underscores the gravity of the situation in global credit markets and suggests that risk aversion is likely to persist.

USD/JPY came within a whisker of the 116.50 in overnight trade– a level many analysts view as a critical support for the pair since many of the longer term carry trades were established at that average price. If credit markets continue to malfunction, causing further losses in presumably safe financial instruments, the pressure to liquidate the carry will only accelerate as speculators will lose all appetite for risk. With risk aversion the dominant – perhaps even the only - theme driving currency markets, economic data has been essentially ignored as currency traders focus only on one question – what will the Dow do next?

Today, the US calendar brings CPI numbers which, given yesterday’s PPI data, may turn out be hotter than expected. However, the story of the dollar may take on the familiar dynamic of strength against the euro and weakness versus yen if US equities decline further and traders continue to eliminate risk.

Boris Schlossberg is a Senior Currency Strategist at FXCM.