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Sunday March 9, 2008 - 22:37:53 GMT
Reuters - www.reuters.com

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GLOBAL MARKETS WEEKAHEAD - Investors fear 3rd leg of credit crisis

By Natsuko Waki

LONDON, March 9 (Reuters) - Tight money markets and tumbling stocks and the dollar will heighten worries for investors this week as pressure mounts on central banks facing what looks like the third wave of a global credit crisis.

Last week, money markets tightened to levels not seen since December, when year-end funding problems pushed lending costs higher across the board.

In response, the Federal Reserve unveiled new measures to ease liquidity strains on Friday -- injecting $200 billion into the banking system -- and said it was in close consultation with central bank counterparts.

However, the Fed failed to lift the mood much. Investors, keen to see if any further plan is in the works to prevent a financial market seizure, will scrutinise words from key central bankers including Fed officials this week.

European Central Bank President Jean-Claude Trichet also speaks a couple of times, including at the meeting of G10 central bankers -- who masterminded a joint cash injection plan last year -- in the Swiss city of Basel on Monday.

"It's another round of the credit crisis. Some markets are getting worse than January this time. There is fear that something dramatic will happen and that fear is feeding itself," said Jesper Fischer-Nielsen, interest rate strategist at Danske Bank in Copenhagen.

"Central banks have shown great resolve to try to solve the problems (on money markets) and I'm sure they will do again."

 

NEW WAVE?

Swiss National Bank Vice Chairman Philipp Hildebrand warned last week that the world might be in a new, more dangerous phase of the crisis.

If that is the case, the latest wave is the third one.

The first round began in August when interbank lending dried up as banks realised they did not know which was dangerously exposed to the U.S. subprime mortgage market meltdown.

Then, late last year, pressure intensified again in the money markets -- after some of the world's biggest banks began writing off colossal sums of money -- prompting top central banks to inject billions of dollars into the system.

Renewed problems in the credit market -- including fears U.S. mortgage lender Thornburg (TMA.N: Quote, Profile, Research) might go bankrupt and acute cash flow problems at a Dutch fund -- and concerns over slowing world growth triggered a sell-off in stocks last week.

World stocks, as measured by MSCI .MIWD00000PUS, fell more than 3 percent on the week while the dollar lost more than 1 percent to hit record lows against a basket of six major currencies .DXY at one point last week.

Also reflecting investor jitters, two-year U.S. Treasury yields hit a 4-year low below 1.5 percent <US2YT=RR> as investors flocked to safe-haven government bonds.

The cost of corporate bond insurance hit record highs on Friday and parts of the debt market which had previously escaped the turmoil are also getting hit.

Many intra-euro zone government bond spreads widened to level not seen since the euro's 1999 launch, with investors shunning bonds in Italy, Spain and Portugal and rushing into safe German government paper.

"A funding freeze by lenders, that appears already in progress, could cause first round casualties in Spain, Italy, Ireland, Portugal, Greece and Austria, countries collectively identified as the euro zone liability group," a UBS note said.

 

NEW PLAN IN THE WORKS?

The G10 policymakers, when they met in November in Cape Town, came up with a cash injection plan, with the top five central banks injecting liquidity which provided life support to banks in desperate need of funds to bolster their balance sheets hit by losses on U.S. subprime mortgages.

However, after weeks of calm, stress is building up again in money markets.

The Treasury Eurodollar (TED) spread, which gauges the premium banks pay to access three-month dollar funds over risk-free U.S. Treasuries, has doubled since early February to hit a two-month high of 167 basis points on Friday.

"The level of financial stress is ... likely to continue to fuel speculation of more immediate central bank action either in the form of increased liquidity injections or an early rate cut," Goldman Sachs said in a note to clients.

"And the prospect of a policy response is likely to be a growing risk to pressing negative positions."

But soaring inflation is tying the hands of central bankers keen to bolster economies by cutting interest rates.

Oil hit a record near $106 a barrel, while gold -- a traditional inflation hedge -- surged towards $1,000 an ounce. Prices of products such as cooper, rice, soybeans and palm oil roared to all-time peaks.

"Regardless of fundamentals, the momentum is there so people buy into the idea, be it oil, metals or soft commodities, they want to buy them," said Michael Dicks, head of research and investment strategy at Barclays Wealth.

"We might call it a bubble but you don't fight it." (Editing by Mike Peacock)

© Reuters 2008 All rights reserved

 

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