Asian shares wobbled on Thursday as doubts deepened about Europe's ability to stop its sovereign debt crisis from spinning out of control, with Germany and France split over the European Central Bank's bond buying role.
The focus of concern is shifting to difficulties in securing funds from money markets, where strains are intensifying due to rising government borrowing costs that have made financial institutions reluctant to buy sovereign bonds and lend to each other for fear of counterparty exposure to euro zone debts.
France and Spain will hold bond auctions later on Thursday, and the results are keenly awaited for clues over whether soaring yields can be capped.
European leaders have failed to clear up doubts about the effectiveness of the region's bailout fund, as it has yet to collect funds, aggravating investor jitters, said Yuji Saito, director of the foreign exchange division at Credit Agricole Bank in Tokyo.
Unless the uncertainty over the European Financial Stability Facility is removed, anxiety will persist, weighing on riskier assets and pushing investors to hoard dollars.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> steadied after falling as much as 1.1 percent led by financials <.MIAPJFN00PUS>. Japan's Nikkei stock average <.N225> turned positive, closing up 0.2 percent. <.T>
European stocks were set to fall, with spreadbetters seeing London's FTSE 100 <.FTSE> opening down 0.6 percent, Frankfurt's DAX <.GDAXI> down 1.3 percent, and Paris' CAC-40 <.FCHI> 1.2 percent lower. <.EU> <.L>
The euro hovered near five-week lows against the dollar of $1.3430 hit the day before. With technically bearish sentiment, traders eyed next support at $1.3145, hit on October 4 when markets across the board tanked on fears Greece would default.
The dollar <.DXY> as measured against six major currencies rose 0.1 percent, reflecting risk aversion and weighing on commodities. Spot gold fell as much as 0.3 percent while Brent crude futures slipped over $1 earlier on Thursday.
EURO ZONE SPLIT
Euro zone's second-largest economy France, which has become the bloc's latest member to face market scrutiny over its fiscal deficit despite a top-notch credit rating, called for more aggressive ECB bond purchases.
Germany, however, remains firmly opposed to using the central bank as the lender of last resort, saying it is up to individual governments to put their fiscal houses in order.
Banks have shed their euro zone debt holdings as uncertainty over fiscal reforms in highly indebted euro zone countries has raised the risk of huge losses on their portfolios as prices plunged, and the absence of such key buyers has driven up sovereign borrowing costs sharply.
On Wednesday, 10-year French government bond yields hit their highest level since April at around 3.7 percent while Italian bond yields rose back above 7 percent.
The yield premium of the French 10-year government bond over German Bunds rose to a euro-era high near 200 basis points. French banks are among the most exposed to Italy's 1.8 trillion euros ($2.4 trillion) public debt, holding $416 billion as of end-June.
Spanish 10-year bond yields rose to 6.48 percent on Wednesday, widening the spread over Bunds to 470 basis points.
TIGHT CONDITIONS PERSIST
Tighter market borrowing conditions persisted on Wednesday, with the benchmark unsecured dollar London interbank offered rate hitting a high last seen during a flare-up in the euro zone's problems in the summer of 2010.
Euro/dollar three-month cross currency basis swaps, the cost of swapping euros for dollars, widened to -129.0 basis points, the most since the collapse of Lehman Brothers in 2008.
While spillover to Asia remained small, there were signs the yen market may be feeling the strains as three-month euro-yen interest rate futures eased and the spread between the 2-year swap rate and Japanese government bond yields hit its widest since January.
It reflects a dwindling number of lenders in cash markets and there is a global trend for snapping up cash, said a bond trader at a Japanese bank.
The mood was subdued in Asian credit markets, with the spreads steady on the iTraxx Asia ex-Japan investment grade index.
There is weakness but not too much conviction. The fund flows are positive, cash is building up on the sidelines and very little supplies, said a Hong Kong based trader with a European bank. Cash bonds will outperform CDS which is tracking equities. ($1 = 0.739 Euros)
(Additional reporting by Akiko Takeda in Tokyo and Umesh Desai in Hong Kong; Editing by Richard Borsuk)