LONDON - Germany's 10-year bond yield hit a fresh record low while the euro edged towards its weakest in two-years on Tuesday as doubts grew over Spain's plan to recapitalise its banks and obtain finance for its struggling regional governments.
US stock index futures pointed to a higher open on Wall Street following the holiday weekend, with expectations high that new data on the economy, including Friday's key jobs report, will show the recovery remains on track.
But the deepening euro zone debt crisis overshadowed hopes for US growth or for stimulus measures from China.
"The bad news just keeps coming and if Spain were to ask for a bailout we would see the euro come under more pressure," said Steve Barrow, head of G10 currency research at Standard Bank.
The euro traded at US$1.2530 (S$1.53), not far from last week's low of US$1.2495.
Fears that Spain could need outside help grew after a Spanish government source told Reuters that it planned to issue new debt to recapitalise troubled lender Bankia.
The source also said the government would ask the Treasury to issue and distribute debt to the regions under strict conditions of meeting deficit targets and implementing austerity plans.
Benchmark 10-year German Bund yields fell as much as 1.7 basis points after the report, touching a new low of 1.347 per cent. The June Bund futures contract also hit a record high of 144.58.
ECB policymaker Ewald Nowotny, asked about the problems in Spain's banking sector, said it was up to national governments, not the ECB, to rescue any banks that get into trouble.
Investor reaction to signs the government may have to come to the market for more funds sent 10-year Spanish bond yields back to just under 6.5 per cent, and heading towards the high of 6.53 per cent seen on Monday.
The premium investors demand to hold Spanish debt compared with safer German Bunds rose to 512 basis points, not far from the euro-era high of 515 basis points also set on Monday.
"A 10-year yield spread over Germany of more than 500 basis points and an outright yield of 6.5 per cent are unsustainable levels," said Derek Halpenny, European head of global markets research at Bank of Tokyo-Mitsubishi UFJ.
The concerns about Spain added to uncertainty about the outcome of Greek elections in just over two weeks and an Irish referendum on the EU fiscal treaty on Thursday.
Conservative parties in Greece have an opinion poll lead that would allow the formation of a government committed to keeping the country in the euro zone but it remained a tight race. Ireland is expected to approve the treaty despite anger at government austerity measures.
Fears that the euro zone crisis is spreading saw Italian six-month borrowing costs rise at auction on Tuesday, to hit their highest level since last December at 2.104 per cent.
"While there is a discernible difference in market perceptions of Italy and Spain, Italy remains extremely vulnerable to a further deterioration in sentiment," said Nicholas Spiro at Spiro Sovereign Strategy.
EQUITIES LOOK EAST
The fresh concerns about the euro zone halted a small rally in European shares that was due to hopes of further policy stimulus in China.
The FTSEurofirst 300 was up 0.25 per cent at 986.44 but off a session high of 993.28. Spain's IBEX was down 1.9 per cent at nine year lows.
Chinese media reported that the government might pump as much as 2 trillion yuan (S$402 billion) into the economy this year, although this would be well below 4 trillion yuan of stimulus it did in the wake of the 2008-09 global financial crisis.
This had lifted Asian share markets earlier, sending the resource-heavy Australian market up one per cent, while global shares, as measured by the MSCI world equity index extended their recovery from last week's sharp selloff by rising 0.3 per cent to 301.75 points.
Chinese data this week is likely to affirm economic weakness in the world's No. 2 oil economy. A Reuters poll showed China's official manufacturing managers' index may have eased in May from a 13-month high in April.
In commodities markets the prospect that the euro zone crisis will hurt global growth sent Brent crude oil back towards US$106 a barrel.
U.S. crude oil futures, however, rose 36 cents to US$91.22, after rising more than $1 per barrel.
Gold was up 0.2 per cent at $1,575.16 an ounce while U.S. gold futures for June delivery were up US$6.00 an ounce at $1,574.90.$1,575 an ounce, but both were vulnerable to news from the euro zone.
Spot gold is on track to end May some 5 per cent below its end-April level - its worst monthly performance this year.