HOWZAT

The sudden demise of the yen carry trade, said dealers, is massively exacerbating the prevailing turmoil on global markets.

The panic-stricken flight from equity risk, said one Nomura broker, is producing dangerous chaos on currency markets.

The Bank of Japan, along with other regional central banks, reversed its cash liquidity strategy for a second time in four days, diminishing its sense of being in full control of the situation.

Having drained 2 trillion yen (£8.7 billion) of liquidity from the market on Wednesday, it pumped a further Y400 billion of cash back into the financial system early today.

BACKGROUND

• Elephant slumps in wake of crunch

• Heads on the block, investors call for change

• Credit crunch forces Delek to leave property deal

• US rate cut looks certain after new data

• Bank of America to axe 3,000 after 'our errors'

BACKGROUND

• More pain for private equity industry

• Russian state bank poised to boost liquidity

• House prices‘to stay flat for years’

• Will soaring oil pump up inflation?

• US bank slump goes on

Black clouds loom on horizon

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Float on the job market

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The behaviour of the US Federal Reserve on Wednesday has brought credit-crunch fears back to the market with a vengeance, said one Mizuho Securities currency trader.

The yen soared against a basket of currencies usually associated with the yen carry trade such as the Australian and New Zealand dollars.

“This is happening not because investors are backing the yen or the Japanese economy, but because we are seeing a wholesale unwinding of the yen carry trade as hedge funds that are being burned on equity markets charge out of their yen positions,” a Nomura broker said.

Other dealers said that some hedge funds, desperate to claw back some profits in a week of carnage, had been creating huge short positions in the currencies that would most be affected by the unwinding of the yen carry trade.

One of the favourite trades was to short sell the New Zealand dollar, following comments by Michael Cullen, the country’s Finance Minister, that the local dollar was still “well above its fair value”.

The overnight slump of the Dow Jones industrial average, and bearish comments by Henry Paulson, the US Treasury Secretary — he said that the present turmoil would “extract a penalty” from the US economy — dealt heavy blows to already dented confidence on Asian markets.

The crisis has hit Japan in a holiday week of traditionally wafer-thin liquidity: traders at Mitsubishi UFJ Securities said that the inability by large hedge funds to unwind their positions immediately was “throwing petrol on the fire”.

Brokers on Japanese and Asia markets described a growing mood of fundamental mistrust that companies in the region have adequately assessed their exposure to the sub-prime problem.

Amid dwindling faith in the credit ratings agencies, which for many are viewed as the pillar of safe investment, portfolio managers reported widespread unease today that many Asian banks, especially Japanese, may simply not realise the risk level of certain investments.

A Merrill Lynch “sell” note on Countrywide Financial further battered confidence that the worst of the sub-prime news had already emerged.

The investment bank speculated that Countrywide Financial, America's largest mortgage lender, could go bust because there was now a question mark over whether it could raise cash in the present market.

Henry Paulson, the US Treasury Secretary, said that the turmoil that has hit the global markets would hit US growth but not push it into recession.

The former head of Goldman Sachs told The Wall Street Journal that the plummeting value of equities, sparked by the crisis in the US sub-prime mortgage market, “will extract a penalty on the growth rate” of the US economy.

But he added that “the economy and the markets are strong enough to absorb the losses” without tipping the world’s largest economy into recession.

Mr Paulson emphasised that the troubles had hit markets “against a backdrop of a very healthy global economy with strong fundamentals".

He added: “Looking over periods of stress that I’ve seen, this is the strongest global economy we’ve had.”

Mr Paulson said that the global economy’s strength marked an important difference between the present crisis and the falls seen in markets in 1998, after Russia’s debt default and currency devaluation and the collapse of Long Term Capital Management, the hedge fund.

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