Asian shares and the euro inched up on Wednesday on hopes that warnings of mass credit rating downgrades will push European leaders into coming up with a convincing framework for resolving the euro zone debt crisis at a crucial summit later this week.
Standard & Poor's, which on Monday told 15 euro zone member nations that it may cut their debt ratings, followed less than 24 hours later with a second warning shot, threatening on Tuesday to cut the credit rating of Europe's financial rescue fund.
The rating action weighed on stocks initially, but U.S. stocks picked up a little late on Tuesday after the Financial Times reported that European leaders would discuss boosting the firepower of the euro zone bailout fund.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> was up 0.3 percent, while the Nikkei stock average <.N225> opened up 0.6 percent, with traders expecting the market to stick to recent ranges.
The euro was off Tuesday's lows at $1.3407 with guarded optimism ahead of the European Union summit on Friday and the European Central Bank's policy meeting on Thursday, with market players expecting a rate cut as well as expanded liquidity measures to ease strains in the banking system.
We see scope for some additional short covering between now and the weekend, barring an EU summit failure. One caveat being if the ECB surprises with more aggressive easing on Thursday than the 25-basis-point reduction in the refinancing rate that is generally expected, analysts at BNP Paribas said.
In the latest evidence of the euro zone debt crisis affecting the global economy, a Reuters poll on Wednesday showed Japan's manufacturers turned pessimistic for the first time in six months, boding ill for the fragile recovery from a devastating earthquake and tsunami in March.
European leaders are striving to forge an agreement at the summit to enforce fiscal discipline, and France and Germany want to change EU rules to impose penalties on states that exceed deficit targets -- both measures aimed at staving off further market attacks on highly indebted and vulnerable economies.
Euro zone officials said the leaders may decide on Friday to raise the combined lending limit of their temporary and permanent bailout funds to help contain the spread of the sovereign debt crisis.
The European Financial Stability Facility, to be replaced by the European Stability Mechanism, has already committed some 40 percent of its funds for bailing out Greece, Ireland and Portugal.
Risk aversion ahead of key events this week prompted investors to rush for safe-haven U.S. Treasury bills, driving demand for four-week T-bills to a record at Tuesday's $35 billion auction, sold at a rate of zero percent.
Financial stress in Europe also stayed elevated on Tuesday, with the spread between three-month euro Libor rates and overnight indexed swap rates at 92 basis points, near an almost three-year high of 93 basis points hit on December 1. Generally, the narrower the spread, the greater the appetite for risk.
The spread between three-month dollar Libor rates and overnight indexed swap rates widened on Tuesday to about 46 basis points, marking the largest gap between the two since early May, 2009. The three-month dollar Libor rate itself hit its highest since mid-2010.
Investor caution kept Asian credit markets subdued, with spreads on the iTraxx Asia ex-Japan investment grade index flat in early Asia on Wednesday.
(Additional reporting by Ian Chua in Sydney)