After being driven lower all day long yesterday, USD/JPY finally found its footing in the Asian afternoon session as Japanese retail demand for yield provided an offset the latest bout of risk aversion. A series of negative news stories including the downgrade of US broker dealers, the near 300-point decline in the Dow Jones Industrial index, and the revelation of yet another US mortgage broker filing for bankruptcy combined to create a massive wave of carry trade liquidation spilling over into early Japanese trade with USD/JPY hitting a low of 113.85. However, strong demand from Japanese investment trusts to the tune of more than 180 Billion yen stemmed the tide of selling and pushed USD/JPY all the way to 114.90.

The trade action today suggests that appetite for yield from Japanese retail investors remains insatiable despite the continuous woes in global credit markets. One possible reason may be the considerably more dovish posture taken by the new Japanese Finance minister Fukushiro Nukaga. In contrast to his predecessor, Mr. Nukaga stated that he did not believe that deflation in Japan was completely over and furthermore urged the BOJ to carefully watch world economic and domestic data to avoid mistakes. Mr. Nukaga's statements were a none too subtle attempt to caution the Japanese central bank from raising rates at the next monetary policy meeting in September. At the last meeting in August, BOJ Governor Fukui, hinted that the central bank may indeed do that if market conditions stabilize.

In short, with Japanese rates unlikely to rise materially in the near future the interest rate differential between the yen and the high yielders for Japanese retail accounts was just too tempting to pass up, and today’s rebound serves as a testament to the power of the carry trade despite the turbulence in other markets. Yet as the day progresses the pendulum may swing the other way if US equities see more selling pressure. Although these are the true dog days of summer, traders have seen no letup in volatility as markets remain jumpy and nervous. With little economic data on the calendar, the price action in currencies is likely to be dictated by sentiment of stock investors who are becoming increasingly concerned about the economic implications from the fallout in the credit markets.

In the only other major news of the night, the Swiss KOF index of leading indicators missed expectations, printing at 2.06 vs. 2.15. Today’s result remains consistent with the notion that Swiss economic growth may have peaked, making it far more likely that the SNB may only hike rates once rather than twice for the remainder of the year. Overall the news should weigh on the Swissie if carry trade demand remains strong for the rest of the day.

Boris Schlossberg is a Senior Currency Strategist at FXCM.