Markets rocked by political battles in DC and Rome

LONDON - Financial markets were rocked yesterday by fears that the US government was heading for a partial shutdown and amid renewed political instability in Italy.

Despite a raft of economic news due around the world this week, the focus of attention will likely remain on developments in Washington and Rome.

In the US capital, lawmakers face a deadline of midnight yesterday (0400 GMT) for agreeing a budget deal that will avert the first government shutdown since 1996. A failure to do so could see essential federal services shut and place hundreds of thousands of staff on unpaid leave. Ratings agency Moody's has warned that a shutdown would knock 1.4 percent off the US's annual gross domestic product.

Meanwhile, in Italy, Premier Enrico Letta faces a confidence vote on Wednesday after ministers from Silvio Berlusconi's center-right bloc pulled out of the five-month government. Though Italy hasn't needed a financial bailout like other countries that use the euro, such as Greece and Portugal, it has high debts that have compelled successive governments to instigate wide-ranging economic reforms. The political uncertainty only adds to concern that the reforms program will slip.

"If investors had been hoping that common sense would prevail over the weekend, in either Italy or the US for that matter, then they would have ended up sorely disappointed," said Michael Hewson, senior market analyst at CMC Markets. "Given the protagonists involved in events either side of the Atlantic any other outcome, would probably have been wishful thinking and so it has proved."

Given those uncertainties, investors are edgy at the start of a potentially big week on the economic news front, with the data flow scheduled to culminate Friday with the US nonfarm payrolls report for September. A US government shutdown would incidentally cause the postponement of the payrolls release, providing markets with a further uncertainty in the run-up to the next policy meeting of the Federal Reserve.

In Europe, the FTSE 100 index of leading British shares fell 0.8 percent to close at 6,462.22 while Germany's DAX fell 0.8 percent to 8,594.40. The CAC-40 in France ended 1 percent lower at 4,143.44.

Unsurprisingly, Milan's stock exchange fared worst, shedding 1.2 percent to 17,434.86. However, bond market investors appeared to be holding their nerve, and the yield on Italy's benchmark 10-year government bond was flat at 4.43 percent, having earlier been sharply higher.

"If Letta does not win his confidence vote on Wednesday, then we could see a sharper reaction in the bond markets," said Kathleen Brooks, research director at Forex.com. "Overall, the markets seem to be expecting a resolution from the Italian crisis, after all, political risk in Italy is nothing new."

In the US, the Dow Jones industrial average was down 0.6 percent at 15,161.23 while the broader S&P 500 index fell 0.5 percent to 1,683.43.

How markets end the day will largely hinge on developments in Washington, with the deadline looming. The Senate reconvenes yesterday just 10 hours before the partial shutdown begins.

Recent history suggests that some sort of deal may be cobbled together between the Republican-dominated House of Representatives and the Democrats, who control the Senate as well as the White House.

"As we've seen in the past, the months leading up to the deadline are simply seen as an opportunity for both sides to gain political points, while making a villain out of the opposition," said Craig Erlam, market analyst at Alpari. "It's only in the final 24 hours that any actual progress tends to be made. We can only hope that this is what we're seeing again."

In the currency markets, the euro recovered from early losses to trade 0.1 percent higher at $1.3535 and the dollar rose 0.6 percent to 98.25 yen.

The price of benchmark New York crude was $1.04 lower at $101.83 a barrel as investors fretted about the impact on the US economy and the consequent impact on energy demand.

The mood was downbeat earlier in Asia as well. Japan's Nikkei 225 stock average, the region's heavyweight, led the way down, closing 2.1 lower at 14,455.80. Among others, Hong's Hang Seng index was down 1.5 percent at 22,859.86. South Korea's Kospi ended 0.7 percent lower at 1,996.96. The Shanghai Composite bucked the trend, closing 0.7 percent higher at 2,174.67.