Asian shares wiped earlier gains and fell on Tuesday, weighed by concerns that surging bond yields could stifle debt-ridden Italy's fund raising ability and throw the euro zone deeper into financial turmoil, while Greece struggled to pick a new leader.
MSCI's broadest index of Asia Pacific shares outside Japan fell 0.3%, reversing course after gaining as much as 0.7% earlier. Japan's Nikkei stock average fell 1.3%.
As focus shifted to concerns over Italy's borrowing costs, Asian credit markets remained cautious, keeping a widening bias on the spreads on the iTraxx Asia ex-Japan investment grade index – a gauge of investor appetite for risk. The spread was slightly wider on Tuesday.
Italian Prime Minister Silvio Berlusconi faces a crucial parliamentary vote on public finances later on Tuesday which could sink his government if enough party rebels desert him.
"The new Greek government is providing some optimism, but going forward, the markets are expected to turn their focus to Italy, which is too big to fail, yet too big to bail," said Phillip Futures analyst Ong Yiling.
European shares were expected to rise, tracking gains on Wall Street, with financial spreadbetters expecting Britain's FTSE 100 index to open up 0.6%, Germany's DAX to rise 1.1% and France's CAC-40 to gain about 0.7%.
Chinese shares were supported by hopes for a year-end rally on optimism that Beijing may selectively loosen its grip as inflationary pressures ease and growth moderates.
Seoul shares turned negative to fall 0.8% after being lifted earlier on Tuesday by gains in shipyards and LG Electronics .
Gains in equities and a firmer dollar eased appetite for safe-haven gold, taking bullion off its 6-1/2-week high hit on Monday. Gold inched down 0.2% to $1,790 an ounce on Tuesday after rising over 2% the previous day.
The dollar index against six key currencies inched up 0.2%.
ITALIAN SPREADS WIDEN
The euro fell 0.2% to $1.3745 against the dollar as investors feared that political uncertainty in Italy and Greece could derail Europe's efforts to implement a bailout plan to prevent a Greek default.
The single currency fell as low as $1.3679 on Monday, but stayed within the $1.3608 and $1.3866 range of the past week.
Berlusconi defied intense pressure to resign on Monday, pushing yields on Italy's 10-year bonds to 6.67%, their highest level since 1997.
Italy, the third largest economy in the euro zone, has the biggest government bond market. Borrowing costs hitting the 7% level were widely seen as unsustainable for its debt.
"The threat to the FX market, obviously, is that a country with nominal GDP growth of just 1.8% at the last count and debt totalling 120% GDP cannot sustain 6.5% yields for long," said Kit Juckes, strategist at Societe Generale.
Investor jitters over Italy's debt has helped widen the spread of bonds issued by the European financial stability facility and German government bonds by about 50 basis points over the past month.
The spread on Italian government bonds over Bunds shot up to 490 basis points on Monday, compared with around 350 basis points a month ago.
