For the third night in a row risk aversion flows dominated Asian trade as Nikkei continued to correct its recent gains, but as European trading settled into its morning routine currencies stabilized with EUR/USD recapturing the 1.3200 handle while USD/JPY crawled back to the 100 level. A spate of negative news from Ireland which proposed an emergency budget plan pressured the euro throughout Asian trading with the unit falling to a low of 1.3145 as traders feared that Irish fiscal problems may balloon out of control.

The U.S. dollar capped the week off with a strong rally that may have set the tone for trading in the coming week. Despite a number of interesting political developments since Monday, the price action of most major currency pairs have been consolidative – up until now. Many factors have contributed to the sharp appreciation of the U.S. dollar, but for currency traders, their primary question is whether the rally can be sustained in the new and extremely busy trading week. Before even talking about the event risks, it is first important to remember that next week represents the end of the first quarter for many U.S. corporations and the end of the fiscal year for many Japanese companies. Therefore we may have a lot of action in the currency market that is related more to repatriation than economic fundamentals.

A new trend has emerged in the U.S. dollar this week courtesy of the Federal Reserve’s decision to start buying U.S. Treasuries. However judging from the price action across the financial markets, investors are not entirely convinced that the central bank’s actions will be enough to stabilize the U.S. economy. Stocks and gold prices have retreated after rallying on Wednesday while bond yields recovered. The U.S. dollar has also bounced but remains very weak. Given that the most significant consequences of the Fed’s action are higher bond prices (lower bond yields) and a weaker U.S. dollar, traders should not be distracted by the sell-off in U.S. equities. With no economic data or major announcements from the U.S. on Friday, profit taking has hit the currency market.

Volatility has ripped through the foreign exchange market as the U.S. dollar gave back its earlier gains. Safe haven flows drove the dollar higher at the beginning of the U.S. trading session, but the currency lost value when equities took off. The big story in the foreign exchange today was the Swiss National Bank’s controversial and nuclear decision to intervene in the currency market, raising fears of a global FX war. By coming into the foreign exchange market to sell Swiss Francs, the central bank has driven the Euro and U.S. dollar sharply higher. The gains in these currencies were exacerbated by the rally in U.S. equities and a stronger retail sales report. The rally in the foreign exchange market today indicates that risk appetite has improved.

Chinese central bank Governor Zhou Xiaochuan pledged today to act assertively in restoring confidence in China’s badly shaken financial sector noting that, “If we act slowly and less decisively, we’re likely to see what happened in other countries: a slide in confidence.” Mr. Zhou’s comments may have simply been a rearguard action after markets were clearly disappointed with Chinese Premier’s Web Jiabao speech on Tuesday that failed to offer any new stimulus spending plans aside from the $800 billion program already announced last summer.

For the first time in 11 years, the Dow Jones Industrial Average has fallen below 7,000. Since the beginning of the year, the Dow has fallen more than 24 percent. From its summer highs, it is down close to 47 percent.