Dollar gains, stocks fall as Europe rot feared

SINGAPORE: The US dollar rose and equities fell on Monday, with investors nervous ahead of a Greek vote on unpopular fiscal austerity measures this week that may sow doubts about financial stability in Europe.

Greek lawmakers began debating a package of measures to increase taxes and cut fiscal spending which is critical to winning a new round of international funding to keep it afloat.

A rejection of the austerity plan could greatly exacerbate pressures already reflected by rising Portuguese and Spanish government bond yields, possibly bringing high-risk Europe closer to a chain of sovereign defaults that would blow out interbank funding costs and place heavy stress on the region's banking system.

The risk of a credit event of this magnitude is keeping two-year US interest rate swap spreads near the widest in a year, banking stocks globally at very low valuations and the US dollar breaking out of a downtrend that has lasted a year.

"Contagion would run through government bond markets and via interbank funding markets," said Societe Generale economists about the implications of a "no" vote from Greece. "Such a negative scenario would threaten not only the financial stability of the euro area, but the global financial system with severe consequences for the global economy."

In the background, the world's major economies are at a vulnerable stage, when growth is slowing but inflation remains high or even accelerating in some places, eroding returns on investments and leaving investors unwilling to take many risks.

The US ISM index of factory activity due on Friday may show to what extent the slowdown is temporary.

CONTAGION AND DISARRAY

The US dollar index, which measures its value against six other major currencies, was trading above a downward trendline that began a year ago. It was up 0.3 percent on the day to 75.85 , having risen around 4 percent since May.

The euro slid to $1.4133, down a half a percent and within striking distance of the June low of $1.4070 .

"Markets understand that if this package isn't passed this week, it's going to throw European debt markets into disarray and cause global contagion. That fear alone is generating a bit of selling today," said Greg Gibbs, strategist at Royal Bank of Scotland in Sydney.

Japan's Nikkei share average fell 0.9 percent in early trade, with technology equipment makers the biggest drag on the index.

The MSCI index of Asia Pacific stocks outside Japan was down 1.2 percent , with technology and commodity-related shares the biggest losers.

Hong Kong's Hang Seng index fell 0.7 percent , though the China Enterprises index of mainland stocks bounced from intraday lows after posting the biggest daily percentage gain in a year on Friday.

Asia is home to some of the most well-capitalised banks in the world, though investors kept selling shares of Chinese banks, many of whom are trading at single-digit price-to-earnings ratios based on 12-month expectations, Thomson Reuters StarMine showed.

China Construction Bank's Hong Kong-listed shares were down 1.7 percent , underperforming the broad market, and Industrial and Commercial Bank of China was down 0.5 percent .

The financial sector globally was trading at 9.5 times its 12-month forecasts for earnings, the second cheapest valuation of all the sectors, right in front of energy stocks.

US crude kept a bearish trend in place, with the August future falling 0.6 percent to $90.60 a barrel near last Thursday's four-month low of $89.69.

Commodities have been the weakest link among asset classes vulnerable to a selloff in the face of slowing in industrial activity globally. Oil prices have been slashed by a fifth since May.

Copyright Reuters, 2011