Fears of a global liquidity crisis gathered pace on Friday, hitting stocks and high-yielding currencies, while the European Central Bank and Asian authorities acted to calm surging short-term borrowing costs.
What started as trouble with risky U.S. residential mortgages is now gripping global markets as the fallout hits banks globally, squeezes once ample liquidity and threatens to damage world growth.
World stocks have shed over seven percent since they hit record highs only a month ago. Investors rushed to buy safe-haven government bonds, unwind yen-financed carry trades and moved to scale back expectations for interest rate hikes by some major central banks this year.
Emergency action by central banks -- with the ECB acting for the second time on Friday -- underlined that the risk of a global liquidity crunch was more serious than anticipated.
What we have at the moment is just an all-round sense of panic, said Marc Ostwald, bond analyst at Insinger de Beaufort in London.
Quite clearly there's a lot of deep-seated fear out there and it's going to take a while to resolve this.
MSCI's main world equity index was down 1.5 percent on top of a two percent fall on Thursday.
The FTSEurofirst index hit a 4-1/2 month low and was down 2.6 percent. Asia's major stocks fell nearly four percent. U.S. stock futures were pointing to a weaker Wall Street open after a 3-percent fall on Thursday.
Liquidity was tight across markets even as central banks from Japan to Australia injected extra cash into banking systems, joining efforts by other authorities on Thursday.
The ECB injected more than 61 billion euros into the market in its second operation in 24 hours.
(Action by central banks) signaled that a severe credit crunch represents an imminent risk, and a greater one than the market had anticipated, Tullet Prebon said in a note.
The emergency action has introduced significant uncertainty in the market, with investors trading a 'crisis' scenario.
Dollars were in especially short supply on Friday with deposit rates for tomorrow/next delivery hitting 6-1/2 year highs above 6 percent. This compares with benchmark Federal funds rates of 5.25 percent.
U.S. regulators are scrutinizing the books of some top Wall Street brokers and investment banks for subprime mortgage losses, according to a Wall Street Journal report.
Government bonds rallied on a safe-haven bid. The September Bund future was up 30 ticks.
Investors cut bets on ECB interest rate hike expectations in the face of market uncertainty. The market prices in a 1-in-2 chance of the ECB hiking to 4.25 percent in September, compared with nearly 100 percent last week.
The high-yielding New Zealand dollar lost more than 1 percent against the dollar while the yen was higher across the board.
The iTraxx Crossover index, a widely-watched indicator for European credit market sentiment, widened to 380 basis points. It was the index's blow-out in the past few weeks which triggered broader pricing of risks.
Volatility across markets is hitting banks and corporates as they have a harder time accessing the financing essential in making corporate takeover deals. The DAX Volatility Index is up nearly 8 percent and hit a 14-month high.
Credit woes also hit oil markets, with London Brent crude down 0.5 percent with concerns rising over the health of the global economy. Spot gold rose to $664.90.
-- Additional reporting by Emelia Sithole