The effects are likely to be less severe than have been in the past, as the rest of the world has become more resilient to a US slowdown with reduced dependence on the US consumer. However, adverse developments in the US could affect equity markets, particularly investor sentiments towards emerging market assets.
A further risk to global markets is that of the unwinding of yen carry trades. As noted earlier, in February 2007 markets reacted adversely to the Bank of Japan’s decision to raise interest rates by 25 basis points. In particular, the high-yielding currencies suffered the most, as investors unwound their long positions in these currencies and reduced their short positions in the yen.