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After brutal 2018, world stocks nurse a New Year's hangover

[January 02, 2019] By Sujata Rao

LONDON (Reuters) - World shares started 2019 on a downbeat note, oil prices and bond yields skidded lower and the Japanese yen strengthened on Wednesday as data from China to France confirmed investors' fears of a global economic slowdown.

The U.S. S&P500 and Dow Jones index futures were down 1.5 percent and Nasdaq futures fell 2.3 percent, signaling Wall Street would open in the red on the first trading day of the New Year after closing 2018 with the worst annual loss since 2008.

Weak manufacturing-activity surveys across Asia were followed by disappointing numbers in the euro zone, sending MSCI's index of world shares 0.4 percent lower .

China in particular was in focus, after factory activity contracted for the first time in over two years. The gloom continued in Europe, where the Purchasing Managers' Index for the euro zone reached its lowest since February 2016. Future output PMIs were at a six-year low.

The data suggests there will be no respite for equities or commodities after the losses of 2018.

GRAPHIC: How global markets did in 2018 - https://tmsnrt.rs/2Ss8qjS

A pan-European share index recovered some earlier losses to stand 0.7 percent lower. The Paris bourse led losses with a 1.5 percent fall, as France's PMI fell in December for the first time in two years.

"It's a continuation of the worries over growth. You can see them in the Asian numbers, which all confirm that we have passed peak growth levels," said Tim Graf, chief macro strategist at State Street Global Advisors.

The knock-on effects from China's slowdown and global trade tensions were rippling across Asia and Europe, he said.

"I don't think the trade story goes away, and Europe, being an open economy, is still vulnerable," Graf said.

Copper, a key gauge of world growth sentiment, fell to 3 1/2-month lows , while Brent crude futures fell 1 percent after losing 19.5 percent in 2018.

Commodity-driven currencies also lost ground, led by the Australian dollar. Often used as a proxy for China sentiment, the Aussie fell as much as 0.7 percent to its lowest since February 2016 at $0.70015.

There were also renewed fears in Europe over the clean-up of Italy's banks, with trading in shares of Banca Carige suspended. Carige failed last month to win shareholder backing for a share issue that was part of a rescue plan. An index of Italian bank shares fell 2.5 percent.

SAFETY FIRST

The stock market rout drove investors into the safety of bonds from countries such as the United States and Germany. The 10-year German Bund yield slumped to 20-month lows of 0.18 percent, its biggest one-day fall in two years.

Gold and the yen were the other beneficiaries.

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The German share price index DAX graph is pictured at the stock exchange in Frankfurt, Germany, January 2, 2019. REUTERS/Staff

While gold topped six-month highs, the yen extended its rally against the dollar to seven-month highs around 108.9. It strengthened to a 19-month peak against the euro.

"Traditional safe-haven type flows are going into the yen. As we see increased volatility (on world markets), the Japanese (investors) are probably repatriatriating foreign assets," said Charles St Arnaud, senior investment strategist at Lombard Odier Investment Managers.

GRAPHIC: Japan's yen, stocks set for some turbulence - https://tmsnrt.rs/2S8LwOk

However, the dollar inched up against a basket of currencies and rose half a percent against sterling, which is being undermined by Brexit uncertainty.

The greenback has come under pressure from a fall in U.S. Treasury yields as investors wager the Federal Reserve will not raise rates again.

While the Fed itself still projects at least two more hikes, money markets <0#FF:> now imply a quarter-point cut by mid-2020.

Fed Chairman Jerome Powell may comment on the outlook when he takes part in a discussion with former Fed chairs Janet Yellen and Ben Bernanke on Friday, while the manufacturing survey and the December payrolls report should shed more light when they emerge on Thursday and Friday respectively.

Yields on two-year debt have tumbled to 2.49 percent, just barely above the cash rate, from a peak of 2.977 percent in November. Ten-year yields have dived to their lowest since last February at 2.69 percent.

The spread between two- and 10-year yields has in turn shrunk to the smallest since 2007, a flattening that has been a portent of recessions in the past. The German 2-10 yield curve is the flattest since November 2016.

"What is clear is that the global synchronized growth story that propelled risk assets higher has come to the end of its current run," OCBC Bank told clients.

"Inexorably flattening yield curves ... have poured cold water on further policy normalization going ahead."

(Additional reporting by Wayne Cole in Sydney and Abhinav Ramnarayan in London; editing by Larry King)

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