SENTIMENT in the foreign exchange market has changed dramatically over the past week as investors increasingly question whether the strong performance of risk assets in 2009 can be sustained in 2010.

Monetary policy tightening in both China and India have made investors much more wary. As Greece’s debt problems have come to the fore in recent weeks they have also been a catalyst for increasing risk aversion.
Yesterday, the European Commission endorsed Greece’s austerity plan but nonetheless said that Athens must take further steps to cut public sector wages, which will do nothing to assuage worries about the country.

Investors’ 2009 bullishness has now largely evaporated and risk appetite is waning. Sovereign debt issues, combined with the potential for Chinese and Indian monetary tightening to choke off the global recovery, have led investors to change their views on the markets. Instead of preparing for a global recovery, they are worrying about a double-dip recession.

Negative market sentiment could quickly develop around countries with debt issues – such as Portugal, Ireland and Spain – and spark further weakness in the euro. This is going to continue until we see both concrete and credible moves from the individual governments to reduce their deficits.

At least in the short-term, this scenario should be supportive of the US dollar, which is historically perceived as a safe-haven, particularly against the euro. The ETFS short euro long US dollar exchange-traded currency pair has been the most popular trade so far this year, capturing 50 per cent of new assets and strengthening 1.6 per cent over the past week.

But the euro is not the only currency that has been looking weak. Higher-yielding currencies such as the
Australian dollar and the New Zealand dollar have also come under pressure as people start to unwind risk positions. This has seen rising interest in ETFS short Australian dollar long US dollar and short New Zealand dollar long US dollar ETCs as investors look to take an overarching view on the key macroeconomic themes that are playing out in the global financial markets.