Stocks steadied, bond yields dipped and the euro rose to a one-month high versus the dollar on Friday as investors braced for a key U.S. jobs report that could feed debate over whether the economy is headed for a protracted slowdown.
A raft of grim U.S. data this week has already made investors wary about the near-term economic outlook and pushed 10-year treasury yields below 3 percent for the first time since December this week.
Even as investors weigh whether this signals a soft patch or a prolonged slowdown, markets have begun to come around to the view that this should boost government bonds in the near term as inflationary expectations will be contained.
Brushing aside Thursday's warning from ratings agency Moody's that the risk of a U.S. debt default was small but rising, 10-year Treasuries rose, with yields dipping 1.7 basis points to 3.015 percent from late U.S. trade on Thursday.
Bank of America Merrill Lynch strategists said the popular trade in global bond markets appeared to be putting on curve flatteners as markets expect softer growth and more moderate inflationary pressures.
Anticipating a weak jobs reading later on Friday, analysts have already cut their forecasts on non-farm payrolls growth to 150,000 from 180,000 previously, according to a Reuters poll.
The spread between 10-year notes and two-year bills, a proxy for the curve, has narrowed to about 256 basis points, compared to nearly 290 basis points in early February.
The bullish outlook on bonds rippled over into Asian markets, with local currency bonds enjoying a good run so far this quarter on hopes that aggressive policy tightening in the region may be coming to a close.
Measured in dollar-adjusted terms, total returns for the broader JP Morgan GBI-EM Asian index are 1.44 percent so far this quarter, compared to less than 1 percent in the March quarter. Foreigners have bought nearly five trillion yen ($62 billion) worth of JGBs in the past six consecutive weeks of net buying.
Tighter monetary policy is still likely, because policy rates are still low relative to current and average historical underlying inflation rates, but if headline inflation rates stabilize, the amount of tightening that we are likely to see in the coming months is mostly priced into bonds, DBS said.
Still, a weak reading on payrolls could further dent demand for risky assets at a time when the end of the Federal Reserve's $600 billion bond purchase program is in sight and U.S. policymakers appear reluctant to offer more support to the ailing economy.
Japan's Nikkei <.N225> share index fell 0.5 percent after losing 1.7 percent on Thursday, with political uncertainty continuing to weigh on sentiment, though cheap valuations and options-related short covering may provide some support.
The MSCI index of Asia Pacific shares outside Japan was broadly steady with industrial and financial stocks leading gains.
Stocks have had a mixed week as PMI data on Wednesday showed factory growth slowed in major Asian countries thanks to tightening credit conditions and a severe drought in parts of China, though some bargain hunting meant markets were set to post their first weekly gain in six weeks. Similar reports showed slowdowns in manufacturing growth in Europe and the United States.
But in a sign that valuations are getting attractive again, the MSCI Asia ex-Japan forward 12-month earnings currently is at 11.8 compared to an average of around 12.8 this decade while forecasts for earnings growth have steadily risen over the past 6 months, according to Thomson Reuters data.
Fund flow data also paint a brighter picture. EPFR Global-tracked funds showed Asia-ex-Japan equity funds were the only major emerging markets fund group to post inflows in the last week of May.
Moody's threat of a U.S. ratings downgrade along with reports that Greece had agreed to new deficit-cutting measures took the wind out of the dollar's strong run, with the euro hitting a one-month high against the dollar.
Against a basket of currencies, the dollar held steady against a basket of major currencies at 74.318 <.DXY>, having touched a one-month low of 74.209 earlier on Friday with market players increasingly wary of a pull back.
Unless there is a truly extreme result, I don't think the market will get all excited about the chances for QE3 and further dollar weakness, said Makoto Noji, senior bond and currency strategist for SMBC Nikko Securities in Tokyo, referring to any fresh round of asset buying by the Federal Reserve.
Moody's warnings revived safe-haven demand for gold, with prices holding around the $1534 per ounce line. Brent crude for July delivery edged higher to around the$115.54 a barrel line.
(Editing by Kim Coghill)