Financial assets are falling partly because of general risk aversion, but also partly because of a withdrawal of liquidity. Banks are becoming more reluctant to lend to each other and are worried about the future of their European debt instruments. PIIGS government bonds were very illiquid yesterday. Liquidity had been strong this year, as central banks maintained accommodative regimes and, more importantly, banks returned to profitability. But it is likely that banks are presently holding back from the marekts for fear of capital impairment by a Eurozone default, or perhaps further sharp falls in government bond prices. With the taps off, there is scope for risk assets to fall further. I am therefore disinclined to take profits on my shorts.

Update: Equally, liquidity could quickly return to the PIIGS government bond markets and money could start flowing into risk assets again. But the TED spread rose again yesterday and gilts and bunds are rising today, which makes me think that we are still in risk-off mode.

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