Central bank intervention last Friday to inject liquidity into the global financial system did not mark the beginning of the end of financial market turmoil. It was merely the end of the beginning. Liquidity injections will not deliver lengthy respite. The next phase of market volatility will be more vicious than before, led by downgraded ratings on credit instruments and followed by further dislocation in the credit markets that will spill over to equity markets.

Credit markets are the big brother of equity markets. In the US and Europe, capitalisation of private debt securities is a combined $28,000bn (€21,000bn, £14,000bn), compared with $23,000bn in equity markets. Although rating downgrades will be a consequence of existing anxieties about credit quality, they will have knock-on effects. Substantial parts of the credit markets are priced off these ratings. This presents rating agencies with serious conflicts of interest that will move centre stage when investors start looking for a scapegoat. Rating downgrades will convert risks into losses. Lossmaking credit funds will suffer redemptions, forcing fund managers to dump well-performing parts of their portfolios as well. Loan covenants will require rated entities to inject liquidity on a downgrade. Where central banks are pushed to ease liquidity more aggressively than their inflation objectives may suggest, currencies will weaken. The yen will rebound.