Fears of global liquidity crisis grip markets

Fears of a global liquidity crisis gathered pace yesterday, hitting stocks and high-yielding currencies, while Asian central banks joined a global campaign to calm surging short-term borrowing costs.

A fallout from high-risk US subprime mortgages is starting to grip global markets as troubles hit banks, squeeze once ample liquidity and threaten to trigger a seizure in the financial system and damage world growth.

World stocks have shed over seven percent since they hit record highs only a month ago. Investors rushed to buy safe-haven government bonds, unwind yen-financed carry trades and moved to scale back expectations for interest rate hikes by some major central banks this year.

"In principle what we have at the moment is just an all-round sense of panic," said Marc Ostwald, bond analyst at Insinger de Beaufort in London.

"Quite clearly there's a lot of deep-seated fear out there and it's going to take a while to resolve this." MSCI main world equity index was down 1.3 percent on top of a two-percent fall on Thursday.

The FTSEurofirst index fell two per cent to a four-and-a-half month low. Asia's major stocks fell nearly four percent.

Liquidity was tight across markets even as central banks from Japan to Australia injected extra cash into banking systems, joining efforts by other authorities on Thursday.

The European Central Bank, which injected a record amount of cash into the markets on Thursday, said it was continuing to closely monitor conditions in the market.

"(Action by central banks) signalled that a severe credit crunch represents an imminent risk, and a greater one than the market had anticipated," Tullet Prebon said in a note.

"The emergency action has introduced significant uncertainty in the market, with investors trading a 'crisis' scenario."

Dollars were especially in short supply yesterday with deposit rates for today/next delivery hitting six-and-a-half year highs near six per cent. This compares with benchmark Federal funds rates of 5.25 per cent.

"The dollars are the problem. The ECB is giving euros, but until the US opens in the afternoon, many European banks have big problems with dollars," a trader said.

Government bonds held up well as investors sought them as a safe haven. The September Bund future was up 50 ticks.

Investors cut bets on ECB rate hike expectations. The market prices in a one in two chance of the ECB raising rates to 4.25 per cent in September, compared with nearly 100 per cent last week.

The high-yielding New Zealand dollar lost more than one per cent against the dollar while the yen was higher across the board.