Your attitude to risk key to 2010 trading

IT WAS no surprise that the Dubai debt scare saw investors running back to safe-havens such as the US dollar, Japanese yen and the Swiss franc. Risk appetite is one of the biggest drivers of the foreign exchange markets.<br /><br />The story of recent months in forex markets has been one of increasing investor confidence, which has seen commodity currencies such as the Australian dollar, South African rand and Canadian dollar bidded higher.<br /><br />Although confidence was rattled by events in Dubai, it didn&rsquo;t take long for currency traders to regain their appetite for risk and dump their safe haven positions. Strategists at RBC Capital Markets pointed out that the news that Dubai World&rsquo;s affected debt is in the region of $26bn rather than $60bn served to underpin risk appetite. Equities are up, risky currencies are on the rise and the US dollar is down.<br /><br />But what ought to be your attitude to risk at the moment? What does Dubai tells us? Should currency traders be looking at retrenching into safe-havens or should they be embracing the currencies that are more closely aligned with risk?<br /><br />There are two ways of thinking about Dubai. One argument is that it is a reminder that economies are still fragile, and that the recovery of the world&rsquo;s stock markets are far from certain.<br /><br />Bad news on this scale suggests that there might be more bad news to come, goes the argument. Although Dubai World&rsquo;s debt may be less than first anticipated, Mark O&rsquo;Sullivan at Currencies Direct says that lenders will have to take the hit if Dubai World does default, which will have negative effects on countries that have exposure to the state-owned company. Sterling, for one, is expected to suffer.<br /><br /><strong>BAD SURPRISES</strong><br />If you think there could be more bad surprises to come, then you should look to move into safe-haven currencies for the coming months. This strategy could serve you well &ndash; not only should you be sheltered from any more bad news, but there are also good reasons to be more bullish on the US dollar and the Swiss franc in their own rights anyway.<br /><br />In the case of the dollar, it is widely seen now as oversold and it will, at some point, start to strengthen as Fed hikes become more likely. This would continue to underpin rises in the greenback even if risk appetite remains on the table.<br /><br />And the Swiss franc was boosted yesterday by the news that the country had exited recession in the third quarter with GDP rising 0.3 per cent on the second quarter. Better domestic news from the European country will also support the franc.<br /><br />The second way to think about the Dubai problem is that it demonstrates that the worst is over for the world economy. Jitters were short-lived, and the markets bounced back very quickly. There is other evidence to support this view, too. A strong Chinese manufacturing purchasing managers index yesterday indicated industrial output was recovering strongly. This should benefit commodity currencies such as the Australian dollar and the South African rand. Such a trend is likely to continue.<br /><br />And even if stock markets are seen as overbought, you might argue, there is a general perception that we are well on the way to recovery. That should increase traders&rsquo; appetite for risk and for currencies which yield better returns. The dollar-funded carry trade has been an extremely profitable strategy and, although the Fed will eventually raise rates, it is expected to do so slowly. It will be a long time before US rates reach those of Australia, Brazil or New Zealand and this will support these currencies further.<br /><br />Dubai World&rsquo;s default is, presumably, the last big shock of 2009 and traders will no doubt spend a lot of time over Christmas deciding exactly what they think about it. Whatever they decide, it could go some way to determining the way they see the world in 2010.