Financial stresses will maintain an atmosphere of fear in the short term, although the key factor is likely to be a sustained increase in volatility with a focus on central bank policy responses.
On Friday, Bear Sterns announced that it had secured emergency liquidity through the Fedâ€™s discount window via JP Morgan. Rumours surrounding the health of the bank has been building for days and this undermined the liquidity position as credit lines were cut.
The markets were close to panic conditions on Monday as financial risk intensified. The sale of Bear Stearns to JP Morgan for US$250mn intensified fears over the scale of bad debts and there were further rumours of another round of write-downs.
The dollar weakened sharply to near 1.59 against the Euro in Asian trading before finding some support from additional Fed measures. The Fed cut the discount rate to 3.25% and also announced further measures to boost liquidity by increasing lending on its own balance sheet.
The Bear Stern difficulties will reinforce market concerns over the financial sector and undermine dollar sentiment, although it will also maintain expectations that the healthy banks and Fed are taking steps to manage the situation.
Markets will also remain on high alert over intervention in the short term. There will be some speculation over an emergency ECB meeting.