Underscored by last week's fall, the correction is not over, and markets will remain vulnerable to a continuing flow of headlines about hedge funds imploding due to their US subprime mortgage exposure.

Equity market volatility will continue and with it, changes in investors' appetite for risk, which, even now, remains far from cautious by historical standards.

That means currencies are set for further swings, some of which could be severe.

The yen, which had been at a four-year low versus the US dollar, and a record low against the euro in early July, rebounded later in the month amid the global equities sell-off to hover around a four-month best versus both currencies. Then early last week, as stocks briefly righted themselves, the yen temporarily fell back.

The opposite swing was seen in Australian and New Zealand dollars and emerging Asian currencies such as the Indonesian rupiah, the Philippine peso and Thai baht, which had pulled back from their strongest run in a decade, only to later rebound.

Highlighting the ties between world stock and currency markets, the trigger for the carry unwinding was the volatile few weeks in global stock markets sparked by concerns about subprime developments and broader credit issues.

This late-July swoon probably represented the long-overdue re-pricing of risk, which was largely ignored by investors for the past year as stock markets surged. The check caused some pain and continues to pose a threat to global growth.

This reaction by carry-trade investors was a replay of the flight to safety at the end of February triggered by a temporary correction in the mainland stock markets that spread around the world.

The yen briefly gained at the expense of higher-yielding currencies, but the swings were reversed as global stock markets resumed their climb, with many hitting multi-year or record highs last month.

The same backdrop remains in place as that of five months ago. Fundamentals for world growth continue to be quite strong. The International Monetary Fund in late July upgraded its forecast for the world economy to a 5.2 per cent expansion this year, from its April forecast of 4.9 per cent.

Growth in China, India and other emerging markets, as well as Europe and Japan, are compensating for the downward revision to US growth. Under the most likely assumption - that subprime problems will not spiral into a full credit crunch capable of derailing continued expansion in the US - it would seem that there is sufficient momentum in the world economy to sustain solid global growth through to the end of the year.

Indeed, the Fed's decision to keep rates steady at this month's policy meeting, when it reiterated that the upside risks to inflation were its predominant concern, temporarily reassured markets and sparked the short-term resumption of the carry trade.

Although Japan's central bank is still expected to proceed with a 25-basis-point rate increase at its August 23 policy meeting (assuming that recent global financial market turmoil cools down by then), Japanese interest rates will remain considerably lower than those of most other economies. The central bank is then likely to proceed only gradually, with further tightening not expected until early next year. This should enhance the appeal of the carry trade.

The yen, in fact, weakened immediately after the Bank of Japan in February announced an increase in its target overnight policy rate by 25 basis points to 0.50 per cent, accompanied with a statement emphasising that further rate increases would be gradual.

We therefore generally expect a resumption of the carry trade, in a replay of earlier this year. Faint-hearted investors should keep their cover, however, as the ride will likely remain bumpy.

Global forecast

Fundamentals for world growth continue to be quite strong

The International Monetary Fund upgraded its forecast for the world economy from 4.9 per cent to 5.2%