Fiscal cliff setback rattles shares, euro

LONDON (Reuters) - Global stock markets weakened on Friday and both the euro and gold slipped, as a new setback in talks to avert a U.S. fiscal crisis and evidence of Europe's ongoing economic difficulties stoked investor nerves.

A proposal from Republican leader John Boehner to avoid the so-called fiscal cliff failed to get support from his party on Thursday, casting fresh uncertainty over talks to avoid across-the-board tax hikes and spending cuts that could push the U.S. economy into recession in 2013.

Anxiety was exacerbated by weaker-than-expected data from key corners of Europe, as German consumer morale dropped to its lowest level in more than a year, Britain revised down growth figures and Sweden slashed its economic forecasts.

The combined worries prompted widespread selling in most major stock markets and saw investors head for traditional safe-haven assets.

The dollar and yen and U.S. and German Government bonds all rose as falls on London <.ftse>, Paris <.fchi> and Frankfurt <.gdaxi> equity markets compounded tumbles in Asia to leave MSCI's global index <.miwd00000pus> down 0.4 percent.

Futures prices also pointed to sharp falls when trading resumes on Wall Street later, with the S&P 500 Dow Jones and Nasdaq 100 all seen losing around 1.4 percent.

Nevertheless, European and global share indices remain on course for their fifth straight week of gains. In the U.S., the S&P 500 is up about 1.8 percent so far this week and 14.8 percent on the year.

"Risk assets look vulnerable over the holiday trading period. The recent performance of key benchmarks has priced in a satisfactory outcome to the U.S. fiscal discussions, which is far from a done deal," said Peel Hunt strategist Ian Williams.

Boehner will hold a news conference at 10 a.m. ET (1500 GMT), likely to focus on the budget wrangling.

Bickering U.S. politicians have only 10 days left to resolve their differences and prevent automatic tax hikes and spending cuts worth around $600 billion kicking in in the new year.

Most observers are still assuming the two sides will avert disaster but tensions are likely to intensify over the normally quiet Christmas period as the deadline draws near.

"The markets are likely to interpret this as signaling even tougher negotiations in coming days," Mohamed El-Erian, chief executive of bond giant PIMCO, told Reuters.

CLIFF HANGER

Oil and gold were also caught up in the U.S. disappointment. Brent crude oil fell more than $1 per barrel before clawing back some ground. Bullion pared earlier losses but remained on track for its steepest weekly drop since June.

"The market volume is thin amidst all these uncertainties, and the year is coming to an end. Many of the investors prefer to take profits and just leave the market," said Brian Lan, managing director of GoldSilver Central Pte Ltd in Singapore.

In currency markets, strengthening appetite for safe-haven assets saw the yen firm and the highly liquid U.S. dollar <.dxy> climb 0.2 percent against a basket of key currencies.

At the same time, concerns over the U.S. impasse dented demand for so-called high-beta currencies that tend to rise or fall with the global growth outlook, such as the Australian dollar and euro.

Weaker German data, which saw consumer confidence unexpectedly drop for a fourth month running, kept downward pressure on the euro which retreated further from a 8-1/2 month high hit earlier in the week, to stand at $1.3200.

"This is a classic risk-off trading environment where the yen did best, followed by the dollar, and higher-beta currencies underperformed," said Audrey Childe-Freeman, head of FX strategy at BMO Capital Markets.

"We have had a very good run in the euro and what we are seeing at the moment is a little bit of profit-taking triggered by disappointment in the fiscal cliff discussions."

CAUTION

Caution also prevailed in Europe's bond markets, where German government bonds climbed at the expense of recently resurgent euro zone periphery debt.

Other safe-haven bonds followed the trend, with U.S. 10-year Treasury yields dipping from an 8-week high hit this week to 1.74 percent and 10-year Japanese yields inching down 0.765 percent.

Jim Barnes, senior fixed income manager at National Penn Investors Trust Co. in Wyomissing, Pennsylvania, saw Treasuries continuing to gain once U.S. markets open later, but expected a correction by the end of the day.

"Treasury yields will likely fall Friday morning and will begin to reverse course in the afternoon as investors become more optimistic a deal will be reached," Barnes said.

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