Asian stocks and the euro fell on Tuesday after ratings agency S&P downgraded Italy and as Greece held talks with creditors to avoid running out of cash within weeks, amid worries that Europe's debt woes will pitch the global financial system into a full-blown banking crisis.
Oil slipped further, after tumbling on Monday on concerns the economic damage wreaked by the euro zone crisis would hurt industrial demand.
The dollar firmed as investors sought safety in the U.S. currency despite expectations of further easing steps by the Federal Reserve this week.
Standard and Poor's cut its unsolicited ratings on Italy by one notch to A/A-1 and kept its outlook on negative, a move that took markets by surprise, warning of a deteriorating growth outlook and damaging political uncertainty.
It only adds to the contagion risk over Greece and has encouraged the flight to safety in markets here, said Stephen Roberts, a senior economist at Nomura in Sydney, pointing to a sharp fall in the Australian dollar on the news.
Japan's Nikkei share average <.N225> fell 1.4 percent, partly catching up with falls elsewhere on Monday when Tokyo markets were closed, while MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 1.3 percent. <.T>
The MSCI index is in bear market territory -- traditionally defined as a fall of 20 percent or more -- after sliding 22.3 percent from its 2011 high in April.
S&P 500 index futures fell 0.8 percent, pointing to a weaker start on Wall Street after U.S. stocks fell around 1 percent on Monday. <.N>
Global markets have been haunted since late July by the twin concerns of the intractable euro zone crisis and worries that the United States is slipping back into recession.
International lenders told Greece on Monday it must shrink its public sector to avoid running out of money within weeks.
Telephone talks will resume later on Tuesday between Greek Finance Minister Evangelos Venizelos and European Union and International Monetary Fund officials.
The finance ministry in Athens said the talks were close to agreement on the steps Greece must take to secure the next installment of aid, worth about 8 billion euros, it needs to pay salaries and pensions next month.
In the near term, it comes down to whether Greece will get the next tranche as strains in the interbank market are easing a bit, said Koji Fukaya, chief currency strategist at Credit Suisse in Tokyo.
The euro fell 0.5 percent after the Italy downgrade to trade around $1.3615, while the Australian dollar -- which is influenced by expectations for commodity prices and so sensitive to the outlook for global demand -- slid to a one-month low of $1.0166.
The dollar rose 0.3 percent against a basket of major currencies <.DXY> and the 10-year U.S. Treasury yield was steady around 1.956 percent, not far off the 1.879 level reached last week that was its lowest in 60 years.
Long-dated Treasuries have been outperforming on expectations the Federal Reserve, which begins a two-day policy meeting later on Tuesday, will try to push down already low long-term interest rates by tilting its portfolio toward longer-dated bonds.
A flight to safety also boosted Japanese government bonds, with the benchmark 10-year yield falling 2 basis points to 0.985 percent.
Oil has weathered much of the turmoil in financial markets over the past month thanks to supportive fundamentals, such as diminished North Sea production and healthy Chinese demand, but succumbed to broader macroeconomic pressures on Monday, when Brent crude dropped more than $3 a barrel.
Brent eased 0.3 percent to $108.88 a barrel on Tuesday, while U.S. crude fell 0.4 percent to $85.40.
Copper was steady around $8,359 a tonne, after tumbling 3.8 percent on Monday, its biggest one-day loss since March, to a nine-month low.
Gold edged up a touch, but remained below $1,800 an ounce after tumbling nearly 2 percent in the previous session as investors favoured Treasuries and the dollar over the precious metal as their safe-haven assets of choice.
(Editing by Kavita Chandran)