World stocks slipped and Wall Street looked set for a poor start on Wednesday as investors cut back on risky assets and sought safety to assess how recent market turmoil has affected the real economy.
The low-yielding yen and safe-haven bonds gained in a move to relative safety.
Money markets remained tight with euro overnight interbank lending rates at six-year highs as banks remain reluctant to lend to each other -- a key concern for investors who worry about a credit crunch.
Banks are paying a higher premium for cash to secure their future financing with many of them and their investment vehicles having difficulty refinancing short-term funding as result of the near-closure of the asset-backed commercial paper market.
Next week will be critical with analysts projecting around $113 billion of euro commercial paper due to roll over between September 11-18. This is larger than the $100 billion that matured in mid August.
One major concern is that credit worries will spill over into the global economy.
Data showed euro zone services sector growth cooled slightly in August with future business expectations at a 4-1/2 year low over worries that market turbulence could hit growth.
Markets are still nervous. While things have relatively calmed down, there is a big risk out there and there is more bad news to come. Clearly volatility is higher now, said Laura Ambroseno, currency strategist at Morgan Stanley.
The FTSEurofirst 300 index was down 0.8 percent while the MSCI main world equity index was off 0.4 percent. The MSCI index has nevertheless recouped around half of a 13 percent sell-off from July's record high to an August trough, hit in the middle of the market turmoil.
A report on Tuesday showing U.S. manufacturing activity expanded in August, albeit at a slower pace, eased concerns about a recession but underscored the view the Federal Reserve would cut U.S. interest rates soon, cheering Wall Street.
But that mood failed to take hold elsewhere as investors awaited more evidence of how the economy is holding up in the face of fallout from the U.S. subprime mortgage sector.
Further clues will come when the Fed releases its beige book of regional economic conditions later in the day.
The yen, which tends to rise in times of risk aversion, was up. The euro was down 0.9 percent at 156.86 yen and the dollar lost 0.7 percent to 115.50 yen.
The September Bund future was up 29 ticks, deriving strength also from strong short-term funding rates.
MONEY MARKET STRESS
The EONIA rate for overnight interbank lending in euros fixed at 4.458 percent on Tuesday, its highest since October 2001. Euro overnight deposit rates, indicated on Reuters data, stood at even higher levels on Wednesday .
Sterling three-month rates, which have shown particular stress in recent sessions, have been hitting 8-1/2 year peaks. In Australia, three-month bank bill rates hit a 10-year high.
Not only is there no respite in the funding tensions; rates instead are heading ever northwards. That looks set to continue, Societe Generale said in a note to clients.
Just as worrying, there is no longer any obvious driver, no fresh news to stoke the fear. It just suffices that lenders lie low, keeping value at risks at prudent levels, for funding rates to push ever higher.
Central banks have injected liquidity since August to calm money markets but their action has so far had little effect, especially on medium-term funding.
The Bank of England joined in on Wednesday, taking steps on to bring overnight interest rates down for the first time during current storm engulfing world financial markets.
Investors expect the European Central Bank to hold interest rates at its meeting on Thursday while the Fed might cut rates later this month.