Stocks and the euro fell on Tuesday after ratings agency S&P downgraded Italy and as Greece held talks with creditors to avoid running out of cash within weeks, amid worries that Europe's debt woes will trigger a full-blown banking crisis.
Oil and copper prices steadied, after tumbling on Monday on concerns the economic damage wreaked by the euro zone crisis would hurt industrial demand.
The dollar firmed as investors sought safety in the U.S. currency despite expectations of further easing steps by the Federal Reserve this week.
Euro STOXX 50 index futures futures fell 0.7 percent, tracking declines on Asian exchanges. Futures for Germany's DAX and France's CAC-40 also fell, while financial spreadbetters called the FTSE 100 <.FTSE> to open down as much as 0.6 percent. <.EU> <.L>
S&P futures also fell 0.7 percent, pointing to further weakness on Wall Street later in the day after U.S. stocks slid around 1 percent on Monday. <.N>
Whilst the downgrade and negative outlook for the Italian economy are no surprise, the fact that the crisis has moved from a peripheral country to a core country is enough to spark some risk aversion today, said Jonathan Sudaria, a dealer at Capital Spreads in London.
Japan's Nikkei share average <.N225> fell 1.6 percent, partly catching up with falls elsewhere on Monday when Tokyo markets were closed, while MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 0.7 percent.
The MSCI index is in bear market territory -- traditionally defined as a fall of 20 percent or more -- after sliding 21.8 percent from its 2011 high in April.
Standard and Poor's cut its unsolicited ratings on Italy by one notch to A/A-1 and kept its outlook on negative, a move that took markets by surprise. The rating agency warned of a deteriorating growth outlook and damaging political uncertainty.
Coming at a time when the world's financial markets are on the edge, warily watching for a default by Greece with knock-on unknown effects on the financial system, the optics of this downgrade stink, said Carl Weinberg, chief economist with High Frequency Economics in New York.
Global markets have been haunted since late July by the twin concerns of the intractable euro zone crisis and worries that the United States is slipping back into recession.
International lenders told Greece on Monday it must shrink its public sector to secure fresh emergency funds and avoid running out of money within weeks.
Telephone talks will resume later on Tuesday between Greek Finance Minister Evangelos Venizelos and European Union and International Monetary Fund officials.
The finance ministry in Athens said the talks were close to agreement on the steps Greece must take to secure the next installment of aid, worth about 8 billion euros, which it needs to pay salaries and pensions next month.
In the near term, it comes down to whether Greece will get the next tranche as strains in the interbank market are easing a bit, said Koji Fukaya, chief currency strategist at Credit Suisse in Tokyo.
The euro fell 0.5 percent after the Italy downgrade to trade around $1.3615, while the Australian dollar -- which is influenced by expectations for commodity prices and so sensitive to the outlook for global demand -- slid to a one-month low of $1.0166.
Tom Fitzpatrick, global head of CitiFX Technicals, told Reuters Insider TV that uncertainty over the direction of euro zone policy would continue to weigh on the single currency.
You at least know what you've got in the U.S., you don't know what you've got, in terms of decision-making, in Europe, he said.
Therefore we feel it's very feasible that you'll see a move lower by the end of the year, probably to $1.30 or below on the euro, and our belief is this may well continue for some time to come.
Putting further pressure on the euro, sources told Reuters that two Chinese state banks had stopped trading currency swaps with some European lenders, adding to concerns about the region's banking system.
The dollar rose 0.3 percent against a basket of major currencies <.DXY> and the 10-year U.S. Treasury yield fell to around 1.94 percent, not far off the 1.879 level reached last week that was its lowest in 60 years.
Long-dated Treasuries have been outperforming on expectations the Federal Reserve, which begins a two-day policy meeting later on Tuesday, will act to push down already low long-term interest rates by tilting its portfolio toward longer maturities in a move known as Operation Twist.
A flight to safety also boosted Japanese government bonds, with the benchmark 10-year yield falling 1.5 basis points to 0.990 percent.
Oil has weathered much of the turmoil in financial markets over the past month thanks to supportive fundamentals, such as diminished North Sea production and healthy Chinese demand, but succumbed to broader macroeconomic pressures on Monday, when Brent crude dropped more than $3 a barrel.
Brent was little changed just above $109 a barrel on Tuesday, while U.S. crude was steady around $85.60.
Copper was also not much changed around $8,356 a metric ton, after tumbling 3.8 percent on Monday, its biggest one-day loss since March, to a nine-month low.
Gold eased about 0.3 percent, falling further below $1,800 an ounce after tumbling nearly 2 percent in the previous session as investors favored Treasuries and the dollar over the precious metal as their safe-haven assets of choice.
(Additional Reporting by Wayne Cole in Sydney, Hideyuki Sano and Lisa Twaronite in Tokyo, Tricia Wright in London and Reuters Insider TV in Hong Kong; Editing by Kim Coghill)