European and Asian stocks fell on Tuesday while government bonds and the yen rose as concerns about the U.S. mortgage market and warnings about currency borrowing prompted investors to cut back on risky assets.

Wall Street fell and swap spreads widened on Monday as problems at two hedge funds managed by Bear Stearns rekindled worries about U.S. subprime mortgages, which cater to borrowers with troubled credit histories, and the potential impact on the world's biggest economy.

This attracted flows into safe-haven government bonds and revived prospects for a Federal Reserve interest rate cut this year.

In terms of the subprime fears related to the Bear Stearns hedge funds ... clearly the markets are very spooked, said Simon Clinch, director of U.S. equities at F&C Asset Management.

The FTSEurofirst 300 index of top European shares was down 0.5 percent, having hit a 6-1/2 year high in early June. The MSCI world equity index was down 0.14 percent.

U.S. stock futures pointed to a flat to slightly firmer start on Wall Street. U.S. data on new home sales and consumer confidence is due.

The yen, whose low yield has encouraged investors to borrow it to fund risky trades, was up 0.6 percent at 165.70 per euro, pulling off last week's record low. It was up 0.6 percent at 123.31 per dollar, off last week's 4-1/2 year low.

Japanese Finance Minister Koji Omi warned that markets should be aware of the risks of one-way bets against the yen, echoing remarks from the Group of Seven finance ministers.

South Korean and New Zealand officials raised concern about the yen's recent weakness, while the Bank for International Settlements said on Sunday there was clearly something anomalous about the exchange rate.


The iTraxx Crossover index, a proxy for risk appetite made up of 50 mostly junk credits, stood at 223 basis points -- more than 30 bps wider than tight levels of 190 in early June -- reflecting concern about the mortgage sector.

There is no uniformity to it as yet, but there are flickers of contagion in financial markets emanating from the distress in credit, said Steven Pearson, chief strategist at HBOS Treasury Services.

From a portfolio management perspective it would seem prudent to sell equities and risky assets and buy bonds on the grounds that the drag on U.S. growth from housing is unlikely to dissipate and tightening credit conditions could also set the financial accelerator into reverse.

In Asia, Shanghai stocks fell as much as 3 percent at one point, while Tokyo's Nikkei average ended the day down 0.12 percent, weighed by a strengthening yen.

We're seeing a slight increase in risk aversion... This does point to some further short-term upside for the yen, said Mitul Kotecha, head of currency strategy at Calyon.

Euro zone government bonds tracked U.S. Treasuries higher with the September Bund future up 15 ticks.

Oil prices fell, weighed by expectations for swelling U.S. inventories and that Nigerian exports could rise. London Brent crude was down 0.7 percent.

Gold was steady at $650.15.