European shares fell in early trading Friday, following Asian markets and extending a decline from the previous session, on mounting worries that borrowing costs in several euro zone countries are at unsustainable levels.
At 0810 GMT (3:10 a.m. ET), the FTSEurofirst 300 <.FTEU3> index of top European shares was down 0.7 percent at 951.66 points, and is on course to fall more than 3 percent over the week, with high sovereign bond yields remaining a major focus for the market. Spanish yields hit a euro-era high at an auction Thursday.
Stocks fell across the board, including the heavyweight banking sector among the losers. The STOXX Europe 600 Banking Index <.SX7P> fell 0.6 percent, and has lost more than 36 percent in 2011, as banks take writedowns on exposure to euro zone peripheral debt.
I'm surprised equities have not reacted even more strongly to what has happened in the bond markets, said Lothar Mentel, chief investment officer at Octopus Investments, which manages $4 billion.
It has the hallmark of a classic liquidity crisis across Europe, where you see countries that perfectly solvent all of a sudden with yields that aren't based on any rational argument.
Asian shares meanwhile, fell for a fourth day in a row.
In a sign that global funding strains may spread to Asia, benchmark three-month euro/yen interest rates futures fell to an eight-month low Friday on concerns that tightness in dollar money markets may prompt non-Japanese banks to raise yen at a higher rate.
Worries over the European debt crisis prompted investors to shed riskier commodities, extending their slide from Thursday, when prices took their steepest tumble since September.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> slid 2.2 percent with the materials sector <.MIAPJMT00PUS> leading the decline, as a slide in commodities prices hit the stock market in resource-dependant Australia.
The index, which fell the past two weeks, was set for its biggest weekly loss in about two months. It was down about 4.3 percent for the week and about 17 percent this year.
Japan's Nikkei stock average <.N225> fell 1.2 percent and also headed for a third weekly loss. It is down about 18 percent so far in 2011.
The euro zone debt crisis is turning into a global liquidity crisis, and leading to a vicious cycle of intensifying funding tightness spurring dumping of risk assets, said Kazuto Uchida, an executive officer and general manager of the global markets division at the Bank of Tokyo-Mitsubishi UFJ.
New Italian Prime Minister Mario Monti Thursday pledged his country would embark on radical fiscal reforms to pull itself out of the debt crisis. But investor jitters remained firmly in place as euro zone governments struggle to raise funds and banks refrain from lending, seizing up market liquidity.
Euro/dollar three-month cross-currency basis swaps, the cost of swapping euros for dollars, widened to -136 basis points Thursday, the most since the 2008 financial crisis.
Focus right now is on short-term dollar funding, but longer-term funding from six months out to a year is also getting tighter. Major central banks must take a coordinated action to ensure all these funding needs are met, Uchida said.
U.S. stocks fell Thursday, as fears over euro zone debt woes overtook more encouraging signs for the U.S. economy after data showed new claims for jobless benefits hit a seven-month low last week and permits for future home construction recovered in October.
Despite positive economic data from the U.S., the market is still focused on Europe and its contagion risk, said Hiroichi Nishi, equity general manager at SMBC Nikko Securities.
The dollar index <.DXY> hovered near a six-week high of 78.467 hit Thursday, while the euro stayed above five-week lows of $1.3421 touched Thursday, with European banks seen repatriating funds as signs of funding stress grew.
But commodities currencies fell, with the Australian dollar piercing through parity.
Copper eased 1.2 percent earlier Friday. Silver slipped more than 2 percent to a one-month low, following a 7-percent slump the day before.
Risk aversion dampened sentiment in Asian credit markets, with the spreads on the iTraxx Asia ex-Japan investment grade index widening by 5 basis points Friday.
We are seeing risk aversion that is spreading across asset classes, with concerns about euro zone fiscal debt crisis, weak auction results in Europe, and worries ahead of this week's Spanish election all leading to deterioration in sentiment, said Dariusz Kowalczyk, senior economist and strategist for Asia ex-Japan at Credit Agricole CIB in Hong Kong.
Investor commitment to a crucial bailout fund, the European Financial Stability Facility, is conditional on improved market sentiment which can only be obtained through troubled countries such as Italy and Greece demonstrating progress in their fiscal reforms.
Euro zone policymakers are aiming to boost the firepower of the EFSF and are working to finalize the legal and technical details on Nov. 29 and to have the leveraged EFSF ready for operation before Christmas.
The yield premium of Spanish 10-year government bonds over German Bunds hit its highest euro-era level above 500 basis points after Spain paid an average yield of 6.975 percent Thursday to sell its bonds, the highest rate since 1997 and just shy of the 7 percent level seen as unsustainable.
Spain faces a parliamentary election Sunday, putting the country under pressure to quickly reassure markets.
(Additional reporting by Mari Saito; Editing by Richard Borsuk and Sugita Katyal)