The global currency storm of the past week is starting to infect the corporate bond markets and may prove harder to contain than last year's May sell-off, Goldman Sachs has warned.
Jim O'Neill, the bank's chief global economist, said investment firms playing the "carry trade" had been caught on the wrong side of huge leveraged bets against the Japanese yen.
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"There has been an amazing amount of leverage on currency markets that has nothing to do with real economic activity. I think there are going to be dead bodies around when this is over," he said. "The yen carry trade has reached 5pc of Japan's GDP. This is enormous and highly risky, as we are now seeing."
Stock markets around the world continued to slide as investors scrambled to liquidate bonds, equities and weaker currencies across the board. Japan's stock market slumped 3.3pc, with falls of 3.7pc in India, 4.6pc in Malaysia and 4.7pc in Moscow, where oil and commodity shares tumbled on fears of a global slowdown.
London closed down 57.5 points at 6058.7 and America's Dow Jones was down 66 points in afternoon trading. Copper prices are down 9pc in a week. Base metal inventories are rising fast.
"The unwind of the carry trade has had an impact across emerging markets," said Kingsmill Bond, a strategist at Deutsche Bank. "The capital exporters in Asia and the Middle East have been relative safe havens: the worst hit are Latin America, South Africa, Turkey and eastern Europe."
The yen has rocketed in a move known as a "short-covering squeeze", rising almost 6pc against the euro and the dollar in a week. Many funds that borrowed at near-zero rates in Japan to chase higher yields abroad are able to close bets at a profit, but some may be forced to liquidate positions - starting a chain reaction through other asset markets, such as gold.
Mr O'Neill said the danger was contagion to low-tier bonds, driving up the cost of borrowing for business.
"Our concern is that the repricing of risk we are seeing could spread to the credit markets. This is potentially more difficult to deal with, and needs watching," he said.
The Itraxx Crossover index used to take the pulse of corporate bonds shows that spreads have widened 43 basis points in a week.
Stephen King, chief economist for HSBC, said it would take two or three weeks to gauge the severity of this shake-out. "The world economy is fundamentally strong, but this reversal of one-way bets built up over years creates great uncertainty. The key worry is that this could reveal a weakness in the architecture of financial markets. We just don't know who is trying to liquidate positions," he said.
Bernard Connolly, chief strategist for Banque AIG, said conditions now are more threatening than they were in the six-week sell-off last spring.
"The carry trade was bound to end with a bang rather than a whimper but this doesn't look to me like forced liquidation yet. However, the yen is going up against all currencies this time and not just the dollar, and stocks are looking more panicky.
"This is going to go on for longer because there has unquestionably been a global financial bubble. Eventually, central banks will reflate but it will have to get worse first. "
Steve Pearson, currency strategist at HBOS, said global markets were waking up to the reality that perma-growth with low inflation was not on the cards. "We're seeing a creeping reassessment of the trade-off between growth and inflation. This is going to weigh on asset prices and threaten risky assets all through the first half of this year."
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