SENTIMENT in the foreign exchange markets has changed dramatically in recent days as investors increasingly question whether the strong price performance of risk assets in 2009 can be sustained in 2010. Indeed, of the major currencies, only the Japanese yen has appreciated in recent days as investors have unwound risk positions, some of which are being funded in yen. Such is the market mood, that even the cut of Japan’s credit rating outlook by Standard & Poor’s yesterday did not substantially affect the yen.

Another key issue affecting investor sentiment has been the deteriorating state of public finances in Europe, particularly in Greece. Its budgetary problems have cast a pall over economies in the Eurozone periphery and may weigh on the euro in coming weeks. Accordingly, over the past week investors have been building short euro positions. Positions in our short euro currency ETC have been the fastest growing holdings on ETF Securities’ platform last week.

The fresh wave of market pessimism has pushed currency volatilities higher in recent days. It should come as no surprise that the highest yielding currencies are bearing the brunt, with the New Zealand dollar/US dollar pair falling 5 per cent over the past week.

Recent moves by China to curb bank lending have resulted in commodity-linked currencies falling sharply. The New Zealand dollar-US dollar pair exhibits the highest volatility of any G10 currency pair and as a result has been one of the most effective ways of playing rising investor risk aversion. Similar moves could be in store for Australian dollar-US dollar, with further downside potential if it breaks through support at $0.89, after already breaching $0.90. Volumes in our short Australian dollar currency ETC contributed over 40 per cent of total trading last week.

The focus moves to the US today with announcement of the Federal Open Markets Committee meeting this afternoon. Investors are looking for hints about when stimulus measures will end. At the end of the week, eyes will turn to US fourth quarter GDP figures and the market is expecting better growth. With investors taking increasingly bearish positions on high yield and commodity currency ETCs, it seems that most currency ETC investors anticipate bad news.