The first full working day of the week in the currency market rekindled risk concerns in global capital markets and as equities sagged from Tokyo to Frankfurt so did the carry trades lifting the yen higher and sending the pound euro and other high yielders lower in the process. As traders awaited the open of the US stock and bond markets after the Labor day holiday, the positive sentiment from Friday’s speeches by Fed Chairman Ben Bernanke and President Bush was wearing off as speculators feared that the policy action from the White House regarding the problems in the US sub-prime market was too little too late to avoid a serious slowdown in the US economy.
The sub-prime fallout has truly become global in nature with losses suffered in Europe and as well as in US. German bank IKB, hurt by its exposure to bad housing loans in the US said today it expected losses of between €600m and €700m or approximately $1 Billion, in its financial year 2007-2008. The news pressured the euro a bit as market players remain skeptical about the possibility of an ECB rate hike this week in the midst of the ongoing turmoil in the credit markets. We continue to believe that the ECB will opt to wait until October, especially in light of the most recent muted inflation data and lower than expected GDP growth in the 13-member region.

Despite the overall tone of caution, some positive economic news did impact trade most notably in Australia where the GDP numbers printed far better than expected at 4.3% annual rate versus consensus calls of 3.8%. Australia continues to surprise to the upside due its strategic position in Pacific Rim as the country retains its status as the primary G10 beneficiary of Chinese growth.

Whether tonight’s news will be enough to convince the RBA to tighten further remains to be seen. The Australian central bank may be concerned as all other major central banks are about the economic consequences of the decline in the credit markets. However, from an economic point of view the country continues to outperform its peers as China insatiable demand for commodities is generating above trend growth in the land Down Under. Should global equity markets stabilize and risk appetite return, the Aussie is sure to attract new carry trade flows as traders anticipate more RBA rate hikes to come.

Boris Schlossberg is a Senior Currency Strategist at FXCM.