Financial markets and the three bears

By Natsuko Waki

LONDON (Reuters) - With the Goldilocks economy long gone, investors this week will wrestle again with the three bears of financial markets -- banking woes, slow-to-stagnant economic growth and rising inflation.

On the blocks are the latest readings on inflation from the United States, Britain and the euro zone, while banks including Merrill Lynch MER.N and JP Morgan (JPM.N) as well as other major corporates such as Philips Electronics (PHG.AS) in Europe will release second-quarter earnings.

Oil prices will be closely watched following U.S. crude's fresh all-time highs above $147 a barrel last week after Iran test-fired missiles and tensions escalated in Nigeria.

But the credit crunch and the havoc it has wreaked on banks may remain uppermost in investors' minds after U.S. bank regulators stepped in late on Friday to prop up mortgage lender IndyMac Bancorp Inc after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which became the fifth U.S. bank to fail this year, will reopen on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision.

The FDIC is hiring more staff in preparation for further failures and has upped its list of troubled banks to 90.

Over the past weeks, MSCI's main world equity index and U.S. indexes have joined European and Japanese counterparts in bear market territory, falling at least 20 percent from recent cycle peaks as investors fret about the drag on growth from escalating oil prices and the abrupt withdrawal of credit from indebted consumers.

U.S. banks were at the centre of the credit and housing bubbles that burst last year, combining with a surge in commodity prices to end the long run of not too hot inflation and not too cold growth that was dubbed the Goldilocks economy.

As more news of mortgage defaults came in last week, those bank shares sank to record lows, according to the S&P bank index .GSPBK, and they could slide further if the banks unveil more bad news in their earnings reports this week.

"The high level of leverage extended to both consumers and investors against a now depreciating asset alongside lax lending standards make a rise in default rates beyond all previous experience likely in most major Anglo-Saxon economies," said Steven Pearson, chief strategist at Bank of Scotland Treasury.

"The epicentre of the crisis therefore shifts from investment to commercial bank balance sheets."

U.S. banks reporting their results this week include Bank of New York Mellon (BK.N), Wells Fargo (WFC.N) and Washington Mutual WM.N.

Data from Thomson Reuters shows that during the second quarter of 2008, analysts have reduced estimates for the financials sector in the DJ Stoxx 600 .STOXX by 3.7 percent, after cutting them by 15.5 percent in the first quarter.

The fate of U.S. mortgage giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N) is also nagging investors. Their share prices sank to record lows last week and bonds plunged on concerns that they would need to raise capital to survive, raising speculation that the government might bail them out.

Fannie and Freddie said on Friday their finances were sufficiently sound to withstand the housing crisis as government officials scrambled to restore confidence in the nation's top mortgage finance agencies.