Global stocks hit the rocks after Asian markets slump

By Alistair Smout

LONDON (Reuters) - A drop in bank shares kept European shares under pressure on Tuesday, after losses in Asian markets sent investors scurrying for safe havens.

After a choppy morning, the pan-European FTSEurofirst 300 (FTEU3) flattened out, having touched its lowest levels since October 2014 in early trade. It remained near its Monday close, the lowest since 2013.

Bank stocks reversed early gains, leaving the STOXX Europe 600 bank sector (SX7P) down 6 percent so far this week. Shares in several Italian banks were suspended from trading after dropping sharply. Other growth-sensitive sectors, such as basic resources (SXPP), also came under pressure.

In all, world stocks <.WORLD> fell 0.4 percent, although S&P 500 e-mini futures (ESc1) were flat.

The search for shelter pushed up the Japanese yen, long considered a safe-haven asset, and drove the yield on Japan's benchmark government bond into negative territory for the first time ever.

Many investors believed that signs of stress in the market for credit default swaps pointed to further declines ahead.

"There is a high probability of a further correction in equity prices, led by banking and energy stocks. There could be a wave of defaults in the energy sector and that will damage the balance sheet of the banking sector," said Lorne Baring, managing director of B Capital Wealth Management. Slowing global growth was clouding the outlook further, he added.

"We are advising our investors to drastically reduce risk and build protection."

However, there were some signs of stabilization. Deutsche Bank (DE:DBKGn) rose 1.4 percent after sinking 9.5 percent on Monday. Late Monday, the German bank said it has "sufficient" reserves to make payments due this year on AT1 securities, after concern had mounted about its ability to maintain bond payments.

Strategists at Goldman Sachs (N:GS) said banks had enough liquidity and that recent capital hikes should reduce the risk of a financial crisis re-run.

On Tuesday, Asian shares saw the biggest losses, tracking the declines in European and U.S. shares on Monday. Japanese Finance Minister Taro Aso warned the yen's rise was "rough", something of an understatement as the Nikkei (N225) nosedived 5.4 percent.

MSCI's broadest index of Asia-Pacific shares outside Japan (MIAPJ0000PUS) fell 1.1 percent. Australian shares hit a 2 1/2-year closing low and would have been lower if not for holidays in many centers.

All of which raises the stakes for U.S. Federal Reserve Chair Janet Yellen when she gives her semi-annual testimony before Congress this week.

"She needs to come across as optimistic without being too hawkish and cautious without being negative," said Jo Masters, a senior economist at ANZ. "Hawkishness or dovishness could easily exacerbate the current sell-off, tightening financial conditions further."

U.S. crude oil rose 2.7 percent to $30.49 and Brent crude rose 1.5 percent. Copper edged higher in quiet trade, with top consumer China on holiday. Gold benefited from the risk-off sentiment and reached a seven-month high, then edged lower as stocks stabilized and looked set to end a seven-day winning run.

MURMURS OF RECESSION

The Bank of Japan's recent shift to negative rates has raised concern that exotic monetary policy is reaching the point of diminishing returns. But talk about a possible recession in the United States has also led to speculation the Federal Reserve will have to slow or suspend plans to normalize rates.

That has pulled 10-year Treasury yields to their lowest since early 2015 and weakened the U.S. dollar, which touched a six-week trough against the Swiss franc as the euro hit a two-week low against the franc. Against a basket of currencies, the dollar edged down 0.1 percent to at 96.494 (DXY).

While the euro was flat against the dollar, bets on volatility ahead for euro-dollar exchange rates surged to a two-month high of 11 percent, as traders bet more on the dollar. That flipped most derivatives pricing in favor of a weaker euro over the next few months.

By the far the biggest mover was the yen, long considered a safe haven given Japan's position as the world's top creditor nation. The dollar dived as low as 114.22 yen from above 121 a week ago. The euro fell as much as one percent to 128.24 yen (EURJPY=).

The yield on Japan's benchmark 10-year government bond touched minus 0.010 percent as the Nikkei stock index tumbled. It was the first time a G7 nation's 10-year government bond yield reached minus numbers, although yields on German bunds have come close.

Southern European bond yields pulled back from multi-month highs on Tuesday, showing some signs of stabilization a day after concerns about global growth and the health of Europe's banks triggered heavy selling.

Such concerns have also seen one market measure of long-term euro zone inflation expectations fall to a record low.