A wave of risk aversion swept across financial markets today as investors worried about instability in world credit markets, leaving stocks sharply lower and driving demand for safe-haven government bonds.
Wall Street looked set for a poor start and European shares dropped more than 1 per cent. Risky currency trades also looked subject to unwinding as the Japanese yen rose across the board.
Emerging sovereign bond spreads widened to 205 basis points over US Treasuries, the highest in almost eight months.
The iTraxx Crossover index, the most widely watched indicator of European credit markets, blew out 35 basis points on the day to 400 basis points, its highest level this year.
"The market has started to see the risk of contagion growing," said RBC Capital Markets senior currency strategist Adam Cole.
"There's been a general assumption that the subprime issue was ring-fenced and that's been questionable in the past few days."
Problems in the US subprime - or risky - mortgage market have been stalking investors for the past few weeks, rattling stocks, widening credit spreads and driving money into safe havens.
The fear is both that the financial system could come under threat and that borrowing costs for companies will rise, hurting earnings. News over the past 24 hours has exacerbated the worries.
Sydney-based Absolute Capital, a hedge fund half-owned by Dutch bank ABN AMRO, said it temporarily closed two funds because it was tough to offload investments in collateralised debt obligations (CDOs).
At the same time, adverse credit market conditions are spilling over into the financing of corporate deals, a backbone of many equity market gains this year.
Britain's Alliance Boots postponed syndication of £5.05 billion of senior debt backing its leveraged buyout, a source told Reuters Loan Pricing Corp.
Similarly, DaimlerChrysler AG's $7.4 billion deal to spin off Chrysler hit a speed bump yesterday when bankers were forced to postpone a $12 billion syndicated loan to finance the transaction.