Credit angst shakes global markets, investors dump risk

LONDON (Reuters) - Investors dumped risky assets on Friday, sending stocks and high-yielding currencies lower and boosting government bonds, as fears grew that a U.S. housing fallout might trigger a global credit crunch.

European credit markets extended their sharp sell-off after spreads blew wider on Thursday on a scale one analyst compared to the events of the 1998 Russian debt default and Long-Term Capital Management hedge fund crisis.

Contagion from the troubled U.S. high-risk subprime mortgage market is growing. The previously resilient emerging market also tumbled, with sovereign bond spreads bursting wider.

Some firms are being forced to cancel or adjust their financing deals as liquidity dries up in credit markets,

"Equities are down, credit is wider, volatility is wider, swap spreads are wider so the whole picture is taking shape of the classical flight to quality move," said Jean-Francois Robin, strategist at Natixis in Paris.

The FTSEurofirst 300 index .FTEU3 fell as much as one percent to a 4-month low, on top of a 2.8 percent drop on Thursday, before recovering slightly.

MSCI main world equity index was down one percent, pulling further away from its record high set only a week ago.

"If sustained, the recent sharp rise in the cost of credit will bring to a halt the financing of takeovers or even new investment. It could also substantially impair equity valuations... A sustained rise in the cost of capital would put overall economic growth at risk," UBS said in a note to clients.

All the key indexes in Asia were in the red. Chinese shares, which have shown resilience earlier this week, also fell.

Wall Street suffered its worst fall since February on Thursday and volatility hit a one-year high after disappointing corporate earnings fanned concerns about the health of the U.S. economy.

SPREADS AND CARRY

The iTraxx Crossover index, mostly-widely watched indicator for European credit market sentiment, widened 30 bps to 435 bps -- around 250 bps wider than levels in mid-June. "Liquidity is just being sucked out of the market... it's fear that the contagion will spread everywhere else," a trader said.

Jim Reid, credit strategist at Deutsche Bank, said Thursday's 40 bps widening was on a scale comparable to 1998.

Emerging sovereign spreads widened to 227 bps, their highest in at least eight months.

Flight-to-safety flows boosted European government bonds, with the September Bund future FGBLU7 up 30 ticks. Citi's aggregate world government bond index fell to its weakest in nearly two months.

The low-yielding yen, long under pressure as a funding vehicle for risky carry trades, hit a three-month high against the dollar. The high-yielding Australian and New Zealand dollars fell around one percent.

Investors are cutting back their bet for the European Central Bank to raise interest rates twice this year. December euribor futures now show barely a 10 percent chance for the ECB hiking to 4.5 percent. For the U.S. Federal Reserve, investors boosted their chances of a 25 bps rate cut to 75 percent.

Elsewhere, London Brent crude LCOc1 fell 0.4 percent after a broader sell-off across commodities markets on Thursday. Gold XAU= rose to $662.30 an ounce.