World stocks and the euro fell back Thursday, prompting a rush to safe-haven government bonds as concerns resurfaced about the euro zone banking system and signs of funding stress.
In a nervous, fast-moving market, the euro fell to a near five-month low against the low-yielding yen and oil tumbled, while renewed buying by the European Central Bank pushed Italian and Spanish government bonds higher.
Banking sources told Reuters that one bank in Asia had cut credit lines to major French lenders while others in the region were reviewing trades and counterparty risks due to concerns about the exposure of French banks to peripheral euro zone bonds
European banks sought to secure dollar funding beyond one week in the currency derivatives market, pushing one gauge of funding costs to its highest levels since the 2008 crisis as investors and banks hoarded funds to protect themselves from further market volatility.
Societe Generale, which suffered a share price rout Wednesday, and French banking peer BNP Paribas both fell around 8 percent at one point while trading in some Italian banks was suspended for excessive volatility.
Concerns have been intensifying about the health of French and Italian banks, which are heavily exposed to troubled euro zone sovereign debt.
"It just goes to show how quickly confidence can evaporate. Markets are incredibly volatile at the moment," said Angus Campbell, head of sales at Capital Spreads.
"Just because you see a bounce early on, does not mean it is going to be maintained. There are concerns, despite what central banks and ratings agencies, say that French banks are over exposed to the peripheries."
The MSCI world equity index fell 0.6 percent, having dropped in 11 of the past 13 sessions.
The benchmark index slipped into bear market territory earlier this week by falling more than 20 percent from its three-year high in May.
European stocks were down 1.1 percent while emerging stocks lost 0.7 percent.
Wednesday, a stream of rumors about a sovereign rating downgrade of France and concerns about the health of French banks caused the biggest widening in the benchmark index of European credit default swaps since 2008.
All three major rating agencies later reaffirmed France's AAA rating, and said its outlook was stable, but markets remain concerned that French banks are among the most exposed to a worsening of Europe's government debt crisis.
U.S. stock futures also erased early gains, falling more than 1 percent and indicating a weaker open on Wall Street later.
U.S. crude oil fell 1.3 percent to $81.77 a barrel.
The euro fell as low as 108.14 yen. It lost 0.1 percent at $1.4151.
MONEY MARKET STRESS
Investors are extremely sensitive about any sign of funding stress in the interbank market, one of the first areas to deteriorate at the onset of the credit crisis in 2007.
Thursday, the one-year yen-dollar cross-currency basis -- which reflects the premium for swapping yen LIBOR into dollar LIBOR -- briefly extended its rise to 56 basis points, the highest since November 2008.
Bund futures were up 12 ticks in volatile trading, with traders saying the European Central Bank was buying Italian and Spanish government bonds in small amounts to protect the two markets from contagion fears.
"The risk is clearly still that we could see this crisis continue to destabilize the euro," said Lee Hardman, currency strategist at BTM UFJ.
"We think there's an increasing risk of recession not just in the periphery but spreading through to the core."
Italian 10-year bond yields were 4 basis points lower on the day at 5.068 percent, while their Spanish equivalents were 3.4 bps down at 5.004 percent.
The dollar was steady against a basket of major currencies. The U.S. currency had been under pressure from speculation the Federal Reserve may launch a third bond-buying program to bolster the economy. It has pledged to keep interest rates near zero for two more years.
The dollar was down 0.3 percent at 76.58 yen, having earlier jumped above 77.00. Dealers reported no intervention by Japanese monetary authorities.
Investors are wary of possible coordinated intervention after Japanese Finance Minister Yoshihiko Noda said he would work closely with the global community to maintain market stability.