Major central banks swept in to calm credit markets spooked by mounting losses on Thursday, with the European Central Bank injecting record amounts of cash to prevent the financial system from seizing up.
The Bank of Canada said it was in contact with other central banks on the global situation and stood ready to add money as needed.
The European Central Bank pumped a record 94.8 billion euros ($130.6 billion) into Europe's money markets as banks scrambled for cash after France's biggest listed bank, BNP Pariba, froze withdrawals from three funds. It cited U.S. subprime mortgage market problems.
Another European fund valued at 750 million euros was frozen too, and a Dutch bank pulled its planned new listing after suffering subprime losses.
The U.S. Treasury said it was monitoring markets and remains vigilant. U.S. President George W. Bush sought to calm fears that a credit market squeeze would unpick economic growth, telling a news conference both the global and U.S. economy were strong.
I'm told there is enough liquidity in the system to enable markets to correct, Bush said.
Traders were on edge, though, waiting to see whether the U.S. Federal Reserve would follow the ECB's lead and pump in cash. Overnight money in the United States opened at 5.5 percent and then eased toward the 5.25 percent Fed target level.
Its daily market operation of $12 billion was a little larger than usual. Global Insight said it expected the Fed to add funds in the very near future to keep markets operating smoothly.
This credit squeeze recently entered a new and potentially more dangerous phase, Global Insight told clients.
U.S. interest rate swaps, a measure of market risk appetite, widened sharply on renewed credit worries. Stocks fell and investors piled into the safety of bonds, pushing down the yield on U.S. Treasuries and European government debt.
In Europe, traders said cash markets were seizing up until the ECB acted. There appears to be a dash for cash both in dollars and in euros, said Nick Parsons, head of market strategy at nabCapital in London.
I'm keen to know whether the ECB is speaking with the Fed. We're interested to know, a European money market trader said, noting conditions were jumpy even after the ECB injection.
The ECB tried to calm markets by injecting the largest amount of money ever in a single operation, saying the aim was to assure orderly conditions in the euro money market. It routinely holds quick market operations when there is a cash imbalance but not since after the U.S. terror attacks in 2001 has the size neared Thursday's level.
The BNP problems had sent judders through European markets already rife with rumors of worsening troubles in Germany. The Bundesbank hosted a meeting with banks involved in the rescue of Europe's highest profile subprime victim yet, lender IKB to arrange details of its 3.5 billion euro bailout.
Nobody wants to lend any money. It's safety first. said Karen Birzler, a money market trader at HVB in Munich.
The cost for banks to borrow money overnight in the eurozone, the world's second largest economic region, shot up to 4.62 percent, the highest level since shortly after the 2001 U.S. terror attacks, and way above the ECB's 4 percent target.
Only when the ECB offered banks extra cash to assure orderly conditions did rates return to normal levels. Money market traders, meanwhile, remained on edge waiting to see whether the U.S. Federal Reserve would inject extra funds as well.
WATCHING THE FED
A Zurich-based money market trader called market conditions crazy since Fed Chairman Ben Bernanke has given no signal of concern that credit markets could unpick the real economy.
The market is acting like a yo-yo. It's all very psychological. The possibility of a credit crunch returning is starting to spook everyone, he said.
A rates strategist at a large European bank in London said that fear of a scarcity of liquidity, whether irrational or otherwise, was taking hold.
It's about lines of credit, fear that credit lines will be called and institutions will have to make money available to others who are facing big credit-related losses, he said.
U.S. dollar deposit rates for tomorrow/next day delivery surged by more than half a point to as high as 5.86 percent from 5.22 percent on Wednesday
Sterling overnight rates also moved up, as traders complained of liquidity drying up. But they also said this might be partly down to summer trading in what was a rumor-filled market.
The scramble for cash forced traders to unwind so-called carry trades, where low-yielding currencies are sold to finance purchases of higher yielding assets. This sparked a broad-based yen rally, but the surge in short-term dollar deposit rates lent the dollar support against most other major currencies.