The turmoil in the capital markets that the authorities assured us was over, some two months ago, has bubbled to the surface again, and credit market contagion is again on the agenda. In the US, a slowing economy and falling house prices are forcing more write-downs by banks that are, then, forced to look for more capital to shore up dodgy balance sheets. Of course, many European banks are not spared these pains either.

With economic conditions still deteriorating, we may not have seen the end of the write-down cycle. Meanwhile, credit-rating agencies are being lambasted for dishing out ratings based on inadequate knowledge, poor analysis and an optimistic bias. In this credit-crunch period, their ratings have often been way off base.

Currently, they are under pressure to maintain investment-grade ratings on bond insurers Ambac and MBIA. If they drop ratings to below investment grade, this will cause further turmoil for the banks, not to speak of other entities. But professionals know it is a sham because the market's implied rating of the two companies, based on credit default swaps, rates them as junk. Meanwhile, Fannie Mae and Freddie Mac are both tottering while Moody's and S&P continue to give them investment-grade ratings.

In the go-go years few people worried about counterparty risk, as the credit default swap market grew at a tremendous pace. Now, those who thought they had bought protection are more than a little concerned that they may not be able to collect if defaults occur.

Hedge funds, which have been busy in this market, may not have sufficient capital to meet payments. Many of the swaps are on below-investment-grade companies, or indices of debt instruments. There is not much transparency in pricing and it is not entirely clear what is deliverable, even if those who wrote the protection have the means to pay up.

Speculators have had a field day in the CDS market over the past few years, while regulators slumbered. The CDS market is in total contrast with exchange-traded contracts, such as futures. In the latter case, there is an organised and regulated exchange, with ready liquidity and transparency. All trades are pretty much guaranteed because the exchange always acts as the counterparty, taking the opposite side of each trade. Also, variance margins help to ensure that only those with sufficient capital can continue to participate in the market.

American consumers have spent the money they received from the fiscal stimulus package. This was a brief and modest shot in the arm for lower-income households. Now, it is back to reality: high fuel and food prices, weakening employment conditions, falling house prices, and lower real wages.

For all the growth in the US economy in the past ten or 12 years, the real median wage has been pretty stagnant. Rising inequality of income distribution has meant that the rich have got considerably richer, with the poor lagging behind. The average Joe is in a particularly bad mood in current circumstances. Low unionisation and a weaker labour market will make it difficult for him to keep inflation from eating away at his disposable income. So to fight back he is likely to turn his attention to pushing for greater protectionism, and that would be decidedly inflationary.

Bernanke will feel lonelier on the FOMC, as another member calls it quits. His academic soul-mate Frederic Mishkin is leaving next month to go back to the comfy world of university teaching. This is undoubtedly the smartest decision that Mishkin has made as a governor at the Fed. Why hang around when the going can only get tougher?

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Iraj Pouyandeh is a strategist and senior portfolio manager at LOM Asset Management. He manages the LOM Global Equity Fund. For more information on LOM Asset Management please visit www.lomam.com