Quarterly earnings results from banks continued to disappoint the market, pushing spreads wider and leading to further price declines in the money market fund for the month. While bad news from the financial sector continued to emerge throughout August, September was marked by the worst days the financial market could have imagined since the Great Depression.

The Fed injected $70 billion into the markets, the most since the September 2001 terrorist attacks, in an attempt to bring borrowing costs down after the Lehman bankruptcy led to cash hoarding within the interbank markets. The Fed also added $50bn in temporary reserves to the banking system, pushing down the rate for overnight loans between banks to spur lending and ease a crisis of confidence in financial markets. On 16 September the Fed extended an $85bn two-year collateralised loan to AIG, the largest US insurer and a key player in the derivatives market, and acquired a 79.9% equity stake in the company, in an effort to keep it afloat. On the same day the Bank of England and the European Central Bank injected billions of Dollars into global money markets and the Bank of China cut interest rates for the first time in six years and lowered capital reserve requirements for its smaller banks. The ECB allotted roughly $43bn (€30bn) in a one-day money-market auction.

Finally, the House of Representatives stunned investors by voting to reject the $700bn rescue bail-out plan and put on hold the expected Troubled Assets Relief Program (TARP). The vote effectively scuppered the US government's plan to remove the toxic assets from US financial institutions although there has been a renewed push on Capitol Hill to get this through.

The Federal Reserve kept the US interest rates at 2.00% during the quarter. Despite the tremendous market turmoil, ECB chairman Trichet maintained that market correction was necessary and that Europe was equipped to deal with the financial crisis. In order to aid this we have seen the European Central Bank loan €120bn to eurozone banks to ease interbank tensions. The European Central Bank maintained their strong anti-inflation stance keeping the rates on hold at 4.25% but with Euro Libor levels still punching new highs it is difficult to see how long this can continue and concerted action by the central banks is widely expected by some market participants.

With UK inflation getting higher and higher, the Bank of England decided to keep interest rates at 5.00% despite the continued global market turmoil and slowing economic growth. However, the BOE continued to inject liquidity, on a side of Fed and ECB, to ease lending within the banking system.

Again during quarter three 2008, long-dated financials bore the brunt of the sell-off, particularly in troubled US commercial and investment banks, and the market aggressively sold off floating rate bonds and moved into lower risk assets.

Liquidity in money markets has varied considerably over the credit crisis and we managed to sell our whole exposure to Washington Mutual late August, way before the bank went bankrupt. We have also tried to lighten exposure to longer dated instruments whenever liquidity has temporarily improved.

At the end of first quarter 2008 early indications were that the US Federal Reserve bailing out of Bear Stearns via JP Morgan may have been a turning point in the credit crisis. As a result there was renewed optimism in the market with April and May seeing the yield on government bonds rise sharply and credit spreads tighten.

The second quarter was set apart by the continuing rise in Eurozone inflation (year on year: 3.3% in April, while it was 3.7% in May). As a result Euro Libor rates continued to increase slowly from 4.72% at the start of April to 4.85% at the end of May. At the beginning of June Jean-Claude Trichet, President of the ECB, spoke of the dangers of higher inflation and a strong euro. His words gave a clear indication that interest rates would be hiked in July if this continued and the market moved to price this in with Euro Libor rates jumping 10 basis points to 4.95% on the day. At the end of June, year-on-year inflation soared to 4.0% reinforcing the view that the ECB would hike interest rates by 25 basis points to 4.25% at the July meeting. In spite of the hawkish tone coming out of the ECB, future hikes in interest rates priced in following Trichet's comments in June have since been scaled back by the market on the back of a slowing Eurozone economy.

With the Federal Reserve signaling the end of interest rate cuts following the 25 basis points cut in April, attention shifted to the credit crunch 'contagion' and its impact on the real economy. With inflation rising to 4.2% at the end of May Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve, will struggle to use the Fed Fund target rate as a tool to spur growth in the face of a slowing economy and a weak dollar. The Fed will be hoping for a resilient US economy in the second half of the year with tax rebates and the presidential elections buoying the wider economy and staving off the lurking threat of stagflation.

The Bank of England cut rates by 25 basis points to 5.00% in April, balancing the risk of higher inflation against domestic economic concern. However, Mervyn King, Governor of the Bank of England, spoke of his concern for the UK economy following April's 3.3% year-on-year inflation number which prompted a letter to the Chancellor to explain breaching the 3% upper target. The direction of the economy, inflation and house prices will be key to future rate decisions but current expectations are now for a pause. UK Libor rates fell from 6.00% at the start of April to5.71% in mid May before spiking back up 5.95% in June.

During the second quarter the rise in the price of financial paper due to spread tightening was more than offset by the negative impact of rising Libor rates and a couple of downgrades.

Continuing the trend seen in the last quarter of 2007, Libor rates in the US, Europe and UK continued to come down in January suggesting that liquidity was returning to the market and banks were once again willing to lend to one another. However, the good news was short lived and market sentiment turned sharply as news of a E5bn unauthorised trading loss at Societe-Generale materialised and the market became nervous that additional write-downs could emerge. Furthermore, downgrades by the rating agencies, the continued uncertainty surrounding the monoline insurance sector and the near collapse of Bear Stearns rattled the market. As a result the market-sought refuge in short-term government issuance, a phenomenon known as "flight to quality", pushing the spread on money market paper issued by corporate entities even higher. The combination of rising Libor rates and a fall in the price of financial paper due to spread widening led to further price decline during the quarter.

With growing signs of a deeper recession than previously thought, the Federal Reserve surprised the market with emergency cuts. During the quarter the Fed Fund target rate fell from 4.25% to 2.25% with 3 month USD Libor moving broadly in lock step from 4.75% to 2.75% at the end of March. The Fed also acted swiftly to provide liquidity to the interbank market with the introduction of the Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF).

With European inflation at the highest level since the Euro was adopted, the European Central Bank was under renewed pressure to keep interest rates at 4.00% despite the continued global market turmoil and slowing economic growth. Balancing the risk of higher inflation against domestic economic concerns, the Bank of England decided to follow the December cut in base rates with an additional cut of 25 basis points in February, from 5.50% to 5.25%. The 3-month GBP Libor rate came down in January before rising in February and March to 6.00%.

USD
The month of December saw libor rates under upward pressure as a result of insufficient liquidity in the global financial system. However, by the end of the year it had become clear that the combined effect of liquidity injections and the aggressive easing stance taken by the Fed looked set to create a strong and lasting downward impetus on short term interest rates. While the inflation outlook is not too clear yet, the only imponderable appears to be the depth of the US economic slowdown.

EUR
The month of December witnessed Euro rates taking a knock from the effects of the very adverse liquidity conditions in markets. However, in an effort to recover from the situation, the ECB aggressively pumped liquidity into the system to alleviate the absence of liquidity, alleviating the raging tone in the market.

GBP
December was witness to a significant easing in the stressed state of the money market. This was due to the strenuous efforts of the central bank, pushing liquidity into the system, and beginning to cut headline interest rates. As is the case in the US, there is still some lingering risk of inflation in the UK mainly due to energy prices. Longer term, it is to be expected that the weakness in the housing sector and retail sales will persuade the Bank of England to maintain its easing bias.