Daily Forex Commentary
By Jack Crooks

Key News
- Japanese core consumer prices fell slightly for a fourth straight month in May. (Reuters)
- Japan is not considering setting up a new investment body to more actively manage the nation's huge pool of reserves. (Reuters)

Key Reports
8:30am: May personal income. Expected: +0.6%. Previous: -0.1%.
8:30am: May personal spending. Expected: +0.7%. Previous: +0.5%.
9:45am: June Chicago PMI. Expected: 57.5. Previous: 61.7.
10:00am: End-June Reuters/University of Michigan sentiment index. Expected: 84.0. Previous: 83.7.
10:00am: May construction spending. Expected: +0.2%. Previous: +0.1%.

Quotable
Life means learning to abhor
The false, and love the truth.
- Robert Browning

FX Trading - Risk cometh! Will liquidity goeth?
We recently mentioned the reflexive relationship between the act of lending and the underlying collateral that supports lending, ie the same underlying collateral that supports a loan is bid up in price by the act of lending itself, as described by George Soros.

This relationship helps explain why liquidity, seeming so abundant during asset-price booms, can "inexplicably" dry up so fast. The players come to the realization that the castles built to the sky rest on a very thin foundation. Okay ... nothing new here, but the history of busts past we have forgotten about.

What is new during this massive gorge of credit we have witnessed, a la hundreds of trillions worth of derivatives, is the notion, idea, belief, hallucination, dream that because these derivatives have been parceled out into smaller baskets and spread across a greater number of investors, that risk is therefore reduced.

Financial theory holds that if you spread risk you tend to reduce your relative risk, a la modern portfolio theory. But try as we might to feel good about this, we can't. Maybe it's because we know modern portfolio theory is based on the incredibly flawed notion of the Gaussian Bell Curve - a fantasy created for the Capital Asset Pricing Model and the elegant curve of the efficient frontier to make sense.

We know in the real world we can only properly quantify risk after the fact. The shape of the curve isn't always a bell and those pesky outliers that should rear their ugly heads only once in a million or so years, according to the theory, have a way of showing up much more frequently.

Our point, if we are making one, is that at some stage the system must reach saturation no matter how many little "safe" parcels are created. And another question we ponder: Is there a qualitative difference if a whole bunch of smaller investors - closer to the ground of the real economy - go belly up instead of one or two big ones?

Adding fuel to our burning questions was this from the front page of the London Financial Times on Thursday (we have emphasized the good part). Commenting on the global bond deals being pulled from the market because of the problems in the US subprime market, HSBC chairman Stephen Green said he was "worried by the degree of leverage in some big-ticket transactions nowadays" and felt "something is going to end in tears".

He also warned that losses could be higher because the parceling out of risk to so many parties across the financial system could make it more difficult to arrange a rescue –a comment that highlighted widespread and growing unease among senior banking executives."

The fact is that once again none of the concerns about risk, assuming there are any, seem to matter to currency investors as we close out the week. We say that because of the price action in the Comdols (commodity dollars representing high yielding currencies) going higher and the yen (the world's key funding currency) going lower.

Below is chart of the US dollar index. We continue to believe that if any of this risk stuff starts to matter - the lowly buck will catch a bid on safe-haven flow from US fund managers rushing to salvage some collateral. Stay tuned.

Black Swan offers a subscription-based currency advisory service for forex and futures traders.

Jack Crooks has actively traded in global equity, fixed income, commodity, and currency markets for more than 20 years. He is president of Black Swan Capital, a currency and commodities market advisory firm - BlackSwanTrading.com