Kathleen Brooks, research director at Forex.com, gives her views on the news and events affecting the currency markets.

The markets have been dominated by the sharp drop in the Japanese stock market this morning as investors’ price in the risk of a nuclear meltdown only 150 miles away from Tokyo. This is weighing on overall risk appetite and in mid-morning trading during the European session the German stock index is down more than 2 per cent along with UK stocks. The market easily brushed off positive corporate news including a 2011 profit forecast upgrade from German car-maker BMW. There is only one thought on the markets’ minds and that is Japan. If the nuclear threat moderates then we could see a reversal in recent panic selling, however, for as long as there is uncertainty as to the extent of the damage then risk assets will remain under pressure in our view.

Bonds are rallying across the board especially US treasuries, UK gilts and German bunds as investors seek the safety of government debt. Japanese bond yields have also fallen as the Bank of Japan stands ready to pump even more stimulus into the economy after doubling asset purchases yesterday to more than $150 billion. However, Japanese credit-default swaps have surged to an all-time high of 122 basis points, and it is costing more to insure Japanese debt as investors question the ability of Japan to finance the reconstruction efforts. We are hearing that volume across financial markets is low, as investors choose to wait on the side lines and digest the news from Japan rather than try and catch a falling knife and buy the market before the true extent of the damage is known.

Currently Japan’s Finance Ministry are working on a supplementary budget to help deal with the aftermath of the quake. This budget is likely to exceed the amount announced after the 1995 Kobe quake.

Commodity currencies are under pressure as oil prices continue to moderate. The fears that the world’s third largest economy will fall into recession are seemingly more and more credible as Japan faces a prolonged period of output disruption and energy shortages. This is weighing on the Canadian, New Zealand and Aussie dollars. The Reserve Bank of Australia released the minutes from its last meeting this morning. It remained fairly dovish and cited the downside expectations to growth and inflation. For the time being the Aussie will get moved about by risk sentiment.

Ahead today are some important economic releases including Empire Manufacturing and the big event – the Federal Open Market Committee (FOMC) meeting at 1415ET/1815 GMT. There is a chance that the FOMC may sound slightly more hawkish in their statement due to the continued uptick in economic data and the slight rise in CPI. It will be interesting if the statement mentions the market impact of the Japan crisis, we tend to think it won’t, but if it does then this could spur even more risk aversion as investors become more concerned about the global economic fallout from the crisis.

The dollar, CHF and yen are the safe havens of choice. USD/JPY has been extremely volatile of late and there were rumours that the Bank of Japan stepped in and sold yen this morning as it closed in on the 81.00 level. It is currently trading around 81.50 after reaching a high of 82.00. Right now investors are still happy to hold on to the yen, however there is a risk it will be sold off as bears continue to sell Japanese stocks.

The pound is under pressure but is finding good support at 1.6000. News that Fitch affirmed the UK’s triple A sovereign credit rating was warmly received by the politicians but it its impact in these risk-driven markets is muted. Likewise, the euro is also slipping along with risky assets, but is finding support at 1.3850/60. There is a slight chance that events in Japan have the potential to derail global growth and depress investor and consumer sentiment, which may cause the European Central Bank (ECB) to holds off on next month’s expected rate hike. Eonia rates – inter-bank lending rates – have moderated on the back of this, but ECB members continue with their hawkish rhetoric. Although the Japanese crisis does add a certain element of uncertainty to a rate hike, we think the ECB will bite the bullet in April and raise rates due to their fears over inflation.

The weaker forward looking component of the ZEW index in Germany suggests that although the German economy remains in rude health, there is a risk that the tragic events in Japan have the ability to 'temporarily dampen cyclical' growth in the European powerhouse, a German ZEW spokesman said.  Thus, the risk to the German economic outlook has increased in a matter of days.

Likewise, the news that the European Union had tentatively agreed to a package of longer term reforms to the European Financial Stability Facility (EFSF) rescue fund has been unable to hold investors’ attention long enough to seriously moderate bond yields for Europe’s troubled periphery. Yields on Portuguese ten-year bonds have stalled today and remain at an elevated 7.4 per cent. This could be due to: one, risk aversion causing capital to flow to the relative safety of German bunds; or two, Investors looking at the weakness of the most recent plans to expand the scope and scale of the EFSF, since it does nothing to reduce the actual debt burdens or austerity measures that will continue to plague the weaker European states.

Investors need to make sure they are aware of what is going on in Japan’s nuclear facilities as this will dominate the rest of the session.