It was a nasty flashback to August.
The Bank of Canada and the U.S. Federal Reserve injected huge amounts of cash into wobbly money markets Thursday as lenders lost confidence in borrowers and drove up short-term credit rates around the world.
The Bank of Canada infused $1.57-billion into the overnight market Thursday, the biggest such injection since 2000, surpassing even the large infusions made during the height of the credit crunch in August.
The Federal Reserve also intervened heavily, pumping in $47-billion (U.S.) to maintain its key interest rate.
“It seems like it's a global issue,” said Ted Carmichael, chief economist at J.P. Morgan Securities Canada.
“It's an indication that banks are extra cautious about lending to each other.”
Volatility has been rattling stocks for days, and the Canadian dollar's ups and downs over the past week have been nothing short of remarkable, economists noted.
After zooming up past $1.10 (U.S.) last Wednesday, the currency has since dropped precipitously, closing Thursday at $1.0151. The Canadian currency hasn't seen moves this extreme for at least a decade, economists at Bank of Nova Scotia and Toronto-Dominion Bank said.
Since last January, when faith in securities tied to subprime mortgage lending began to soften, distrust about credit in general has been rising, and risk premiums have been under pressure, said David Wolf, chief economist at Merrill Lynch Canada.
Market fears crested in August, when lenders stopped trusting borrowers and short-term credit dried up.
Central banks injected liquidity daily, nursing the credit markets back to life.
And when the U.S. Federal Reserve cut rates in September, some confidence returned.
But the past two weeks have seen a return of volatility and a renewed distrust about the ability of markets and financial institutions to withstand the fallout of the U.S. subprime problem.
“There's a tremendous amount of fear in markets over all,” said Camilla Sutton, a Toronto-based currency strategist for Scotia Capital.
That's partly because of risk-aversion, too.
With an eye on a slowing U.S. economy, skittish speculators are pulling out of the carry trade market (which makes bets against the Japanese yen) and piling into the safer U.S. dollar, sideswiping other currencies, especially commodity-based currencies such as Canada's.
This week, the queasiness spilled over from foreign exchange and stock markets and into short-term credit markets – which were still on edge anyway, because of the trouble in August.
“We've been noticing there's been pressure in the overnight market for the past few days,” Ms. Sutton said.
Fuelled by rumours about certain banks refusing to lend to other banks, or certain borrowers finding it hard to access credit, interbank lending rates have risen in the past few days, and the Federal Reserve's key rate has been bouncing frequently above the Fed's target.
Thursday, the Bank of Canada needed to intervene to defend its target, too – making a $980-million injection just before noon, followed by another $700-million in the early afternoon.
(The central bank is obliged to defend its target rate. If the overnight rate trades above the bank's target, it needs to lend money at the lower bank rate to drag the market rate back to target.)
Still, the Bank of Canada is being careful not to send signals of panic, Mr. Carmichael said. “They're not indicating that this is anything other than them going about their normal business,” he said.
The broader context of Thursday's liquidity problems, however, can't be ignored, he added. The central banks' injections are the tip of the iceberg, signalling that commercial banks are afraid of lending to each other.
“And if they're cautious about lending to one another, then they'll be cautious about lending to businesses and consumers,” Mr. Carmichael said.
“They're protecting their balance sheets and are defensive.”
With files from reporter Tavia Grant
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