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:

• Libor, the interest rate banks charge each other for three-month loans, eased to 0.7525 percent this week, the lowest level since bankers started reporting the rate in 1986.
• The TED spread, which measures the perceived credit risk in the bank sector (by calculating the difference between three-month Treasury bill rates and bank rates) dropped to 0.57 percent, a level that goes back to before the credit crisis. (The TED spread is discussed in detail in the MoneyWatch Money Library.)
• The Libor Overnight Index Swap, or OIS, which also measures banks' willingness to lend, fell to 0.55 percent, the lowest since February 2008.

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)