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Fear Subsides in World Markets, Taking the Dollar With It

Risk and uncertainty, as those terms are used in the financial markets, refer to two different concepts. "Risk" is a level of fluctuation that you can expect or forecast, usually based on market movements of the past. "Uncertainty" is altogether different -- it's a situation where you don't know what to expect. Uncertainty has prevailed in most of the world's markets for the past two years, but this week, several important equity and credit indicators show that the level of fear is subsiding. And while that's good news for the markets where investors are looking for risk, it may be hurting the safe haven of the dollar.

The intensity of fear in the U.S. stock market has been easing for several months, but this week returned to levels from before all hell broke loose -- that is, prior to the bankruptcy of Lehman Brothers last September.

Fear is measured by the Vix index of the Chicago Board Options Exchange, and it calculates the market's expectation of future volatility of the S&P 500. (It's also a traded option, which investors can add to their portfolios to hedge against market swings.)

After trading at very low levels in 2005 and 2006, the Vix strengthened to the range of 20 to 30 during the early stages of the credit crisis in 2007 and 2008, then shot up to an unprecedented 80 after the Lehman bankruptcy. On Tuesday, it returned to below 30 for the first time since October.

Credit markets seem to be less nervous, too. The Financial Times tells us:

But for the big picture in the U.S., lower levels of fear cut both ways. Fearful investors worldwide have been flocking to the safety of Treasury bills and bonds, and in the process exchanging their local currency for dollars, keeping a floor under the value of the greenback.

Less nervous investors seem to be leaving the dollar's safe haven, and in the process pulling out that source of support. Bloomberg notes that the dollar has fallen against the euro and the yen, to $1.38 and 95, respectively, but also against developing market currencies such as the Brazilian real and South African rand.

"It's a reflection of more risk taking," said Laurent Desbois, president in Montreal of Fjord Capital, a currency fund with $800 million under management. "Capital is leaving the U.S. This will continue for a while." (via Bloomberg)
But if a slightly weaker dollar is what comes from greater investor confidence in the credit and equity markets, I'm all for it.
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