This Weekend's Contemplation - Where the Capital Markets are Now!

Many people are confused as to where the capital markets are today, mostly because there are so many moving parts it is hard to keep them straight. The following article from Yahoo.com gives a good summary of where everything is. Text in bold is my emphasis.

Investors start the final quarter of 2008 this week in an increasingly dysfunctional global market, after weeks of historic turbulence that have prompted a near seizure in lending between banks.

While Washington's $700-billion bailout package is crucial in tackling the worst financial crisis since the Great Depression, doubts remain as to how it could immediately thaw the frozen money and credit market.

This week's data highlight is the U.S. employment report for September but the indicator is unlikely to fully capture the massive shock to the labor market, broader economy and consumer confidence of the events of the past two weeks.

Interbank money markets are experiencing historically high tensions after the collapse of Lehman Brothers, Washington Mutual and the firesale of Merrill Lynch and UK bank HBOS, while a global ban on short selling has caused trading volumes in major stock exchanges to dwindle.

The liquidity crisis is spreading to the Arab Gulf, other emerging markets and Scandinavia, and the U.S. commercial paper market, a vital source of funding for many companies' daily operations, has shrunk to its smallest in almost two years.

All that has backed a stampede into safe-haven U.S. government debt that has sent short-term yields to near zero as prices rocketed.

"It's the most dysfunctional market I can remember in my career of 20 years," said Chris Iggo, chief investment officer at AXA Investment Managers.

"It is the complete questioning of the very fundamentals of how the financial system works. The real key to everything we do is a matter of trust and there is evaporation of trust."

"That's why banks are not lending to each other and people are worried about the creditworthiness of debt and there's a lack of belief in the ability of equities to deliver the earnings that analysts are forecasting."

After more than a week of negotiations, U.S. lawmakers on Sunday were set to sign off on a deal to create a $700 billion government fund to buy bad debt from ailing banks.

Britain might claim another victim to the 13-month-old credit crisis this week. The BBC reported on Sunday the country will nationalize troubled mortgage firm Bradford & Bingley after it took Northern Rock into public ownership in February.

On Friday, the cost of borrowing dollars for three months in the interbank market stood at 3.76188 percent, a full two percentage points above expected official U.S. interest rates -- a record premium.

Numerous liquidity interventions by central banks -- so far the only coordinated action -- have failed to eliminate money market tensions stemming from a global shortage of dollars.

Pressure is growing for policymakers to do more to contain the fast-spreading financial crisis -- delivering an ensemble cut in interest rates for example.

"The clear signal from the market is that these liquidity operations are not working. The money is not getting where it needs to go," said Nick Parsons, head of market strategy at nabCapital. "So, if changing the quantity of money has not worked, then it's time to change its price."

The European Central Bank, which meets on Thursday to decide on interest rates, is unlikely to lower the cost of borrowing until December because it remains worried about persistent inflation pressures.

According to interest rate futures, investors are betting on a 1-5 chance of a half-point interest rate cut from the Federal Reserve by late October.

"Credit is rapidly becoming either completely unavailable or punitively expensive ... The countdown to a dramatically bad economic outcome is therefore running at very high speed," said Tim Bond, head of asset allocation at Barclays Capital.

"Unchecked, the current crisis would turn into a self-reinforcing vortex of defaults, bank capital contraction and deep recession within a matter of weeks."

In these uncertain times, options for investors to invest their capital are diminishing rapidly as stocks and commodities fall, while government bonds are already expensive with some U.S. yields close to zero.

"Investors are trying to do everything they can to safeguard capital. The implication is the continued deleveraging of the financial system and the continued consolidation of financial institutions," Axa's Iggo said.

"There is no credit available to finance consumption and investment. Globally there is a major economic slowdown that's going to last for a considerable amount of time."

Tuesday's release of Reuters September global asset allocation polls will give a useful pointer on how money managers are shifting their assets in surveys conducted after the collapse of Lehman Brothers.

Even emerging markets -- the star performers of the past few years -- are suffering from a departure of foreign capital as investors flee higher-risk assets.

Morgan Stanley analysts say the bank industry panic in the developed world could cause capital inflows into emerging markets to fall by a quarter to $550 billion in 2009, increasing the risk of a global recession and even a currency crisis.

Emerging market stocks, measured by MSCI, are down 34 percent this year, after five straight years of double digit gains. Their developed market counterpart is down 22 percent since January.

In Ukraine, a mix of political and economic uncertainty has led to a sharp fall in the local currency, depleting currency reserves and threatening a full-blown currency crisis.

"Not only will the emerging market economies experience a material slowdown, but the world's capital flows to emerging markets will also likely be significantly reduced, undermining emerging market currencies," Stephen Jen, Morgan Stanley's chief currency economist, said in a note to clients.