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Credit fears haunt stocks; dollar rally pauses

LONDON - Concern about the health of the financial sector drove global stocks to their lowest in nearly two years on Tuesday, while the dollar ran out of puff after rising to its highest this year against a basket of major currencies.

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Wall Street looked set to struggle at the open with U.S. stock index futures all wallowing in negative territory.

Underscoring a worsening outlook for global economic growth, the Bank of Japan cut its assessment of the world's second biggest economy, but a report showing a bounce in German investor sentiment in August helped inject a glimmer of hope.

Still, investors were focused on the financial sector after an article in Barron's renewed worries that a government bailout was needed for the two biggest U.S. home finance providers, Fannie Mae and Freddie Mac.

"Overall the environment for equity markets remains very difficult as it has now become clearer that we are witnessing a more severe economic slowdown," said Tammo Greetfeld, a strategist for UniCredit in Munich.

MSCI's main index for global stocks fell 0.9 percent to 332.50, having plumbed a session low of 332.12 -- a level last seen in September 2006.

The FTSEurofirst 300 Index of top European shares slid 1.6 percent, while MSCI's pan-Asia equities index dropped 1.7 percent, after earlier hitting its lowest level since July 2006.

Oil prices fell on expectations that a weak global economic outlook would hit demand and as a tropical storm in the Gulf of Mexico missed major oil and gas installations. U.S. crude fell to a low of $111.64 a barrel.

Recent slides in commodity prices have now left the Reuters-Jefferies CRB Index down nearly 20 percent from levels seen in early July.

Dollar pauses, bonds rise

While falling crude prices weighed on energy shares, they saved the dollar from the general credit market malaise by buttressing expectations that the United States will not be the only economy to suffer weak growth and fragile asset markets.

The U.S. dollar index, which tracks the greenback's performance against a basket of six major currencies, rose to 77.413 -- the highest since December 2007 -- before retreating to be little changed on the day.

"I'm assuming that what we've seeing is no more than some well-timed profit taking. In the absence of any fresh news, people will be only too well aware that the short-term technical indicators are at extremely stretched levels," said Simon Derrick, head of currency research, at Bank of New York Mellon.

"Everything else, you have to say, really still supports the idea of the dollar continuing to make new ground. In particular, I'd probably highlight the oil story."

The euro was flat at $1.4688, recovering from a fall to $1.4631 earlier, while the dollar slipped 0.3 percent versus the Japanese currency to 109.77 yen, off the session peak of 110.32.

Investors found solace in safe haven government bonds, helping drive the 10-year euro zone bond yield down 3 basis points to 4.11 percent and the 10-year U.S. Treasury note yield down 2 basis points to 3.80 percent.