European shares edged lower and the euro flatlined but yields on safe-haven German bonds rose on Wednesday as worries about contagion from Spain's banking crisis and this weekend's critical Greek elections kept investors on the defensive.
US stocks were also poised for a slightly weaker start and US Treasuries also slipped with a series of economic data and a 10-year note auction likely to dominate trading.
Asset markets remain cautious globally due to the high level of unease over whether Spain's problems could spread to Italy, whether Greece will remain in the euro zone after its June 17 election and what effect Europe's problems will ultimately have on global economic growth.
“Many now believe that the point of no return is getting nearer with the peripheral (European) economies in a somewhat irreversible dynamic, with their economies depressed and their access to capital markets shrinking,” Lee McDarby at Investec Corporate Treasury said.
Pressure was building up in the debt market on Europe's paymaster Germany as the rising cost of shoring up the euro zone was beginning to raise doubts about even its credit quality and affect the price of German government bonds or Bunds.
Germany shoulders the biggest share of financing the bloc's bailout funds, which are already supporting Greece, Portugal, Ireland and will soon funnel aid to Spain too after a weekend deal to lend Madrid up to 100 billion euros ($125 billion).
“Germany is losing quality due to the increasing conditional liabilities that are piling up on the Bund,” Andrew Bosomworth, head of bond fund PIMCO's German unit said.
However, a smooth 4 billion euro sale of 10-year German debt on Wednesday did help to calm some nerves.
“At least for now this auction will serve to calm down the worst fears the market was having going into the auction and should help to somewhat stabilise Bunds,” said Michael Leister, strategist at DZ Bank in Frankfurt.
Ten-year German bond yields were around 1.52 percent, above the recent lows but still at historically very low levels, while the cost of insuring the country's debt against default was barely changed on the week at 109 basis points.
The euro was little changed at $1.2535, close to the middle of a range between its two-year low on June 1 at $1.2288 and a three-week high reached on Monday at $1.2672.
Tension eased slightly in the peripheral European bond markets, though yields on Italian and Spanish government debt remained at high levels of around 6.17 percent and 6.74 percent, respectively .
The cost of insuring Spain's debt against default also eased back from record highs posted on Tuesday, though the rate remains at extremely high.
“It's just a day of consolidation after the severe widening we've seen over the past few days,” said Gavan Nolan, an analyst at CDS data monitor Markit. “Overall the mood is one of caution ahead of the Greek elections on Sunday.”
Five-year credit default swaps (CDS) on Spanish government debt fell 10 basis points to 593 basis points, which means it costs $593,000 annually to buy $10 million of protection against a Spanish default using a five-year CDS contract.
Italian CDS, which have been closely correlated with Spain over recent sessions, also fell, but Italy's one-year borrowing costs shot up from a month earlier at auction on Wednesday.
Italy paid a six-month high of 3.972 percent for one-year funds, compared with the 2.34 percent it paid a month ago for debt with the same maturity.
The country faces a stiffer hurdle on Thursday when it will auction up to 4.5 billion euros of new debt.
Concerns about the outcome of the elections in Greece kept many investors on the sidelines. Parties opposing and supporting the country's bailout, which comes with harsh austerity measures imposed by international lenders, are neck and neck in opinion polls.
The FTSE Eurofirst 300 index of top European shares, fell 0.4 percent to 994.42 points, giving a drop of 10.7 percent since mid-March when Spain first indicated it was struggling to meet its budget austerity targets.
The overriding nervousness in the market was highlighted by a 2.4 percent rise in the Euro STOXX Volatility index.
A choppy trading session in Asia earlier left the MSCI world equity index up 0.2 percent at 301.94 points for a gain of around 3.5 percent from last week's lows for the year.
Global growth worries stemming from the problems in Europe were also heightened after an influential Chinese government adviser said the country's annual economic growth rate could fall below 7 percent in the second quarter if weak activity persists in June.
The forecast by Zheng Xinli, a former deputy director of the Chinese Communist Party's policy research office, is among the most bearish by any government and private sector economist.
Commodity markets, in tune with other riskier assets, were mostly subdued by uncertainty over developments in Europe.
Brent crude gained 36 cents to $97.50 a barrel, with investors awaiting the outcome of the meeting this week of the producer group OPEC. US crude fell 15 cents to $83.17, reversing its gains of the previous session.
Gold perched above $1,600 an ounce on Wednesday, retaining most of its gains from the previous session, supported by its increasing use as a safe-haven asset. - Reuters