SYDNEY Asian shares sputtered on Thursday as U.S. Federal Reserve Chair Janet Yellen's tone of guarded optimism led to an indecisive finish for Wall Street and further weakness for the dollar.
While European banks found a moment of stability, a renewed rush to the safety of longer-term U.S. Treasury debt suggested the flight from risk was far from over.
The euro zone's banking index .SX7E ended Wednesday up 6.9 percent, but still appeared destined for a seventh straight weekly decline in the longest losing streak since 1998.
MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS was flat in early trade, while Australia's main index eked out a 0.3 percent gain.
South Korea .KS11 re-opened from holiday with a 2.5 percent drop as it caught up with losses elsewhere.
The absence of Japan for a holiday might actually help the mood as Tokyo has been the hardest hit market this week. The Nikkei .N225 sank 7.6 percent in just two sessions as a surging yen dimmed the outlook for exports and profits.
In Washington, Yellen generally sounded optimistic about the outlook for the U.S. economy while also acknowledging the risks from market turmoil and a slowdown in China.
Analysts took that to mean a hike in March was unlikely, but further tightening was still possible later in the year.
"Yellen made it clear that while the Fed still expects to continue on its gradual tightening path, policy was not on a pre-set course and would respond appropriately to developments," said Justin Fabo, a senior economist at ANZ.
"The real test may come later, if markets continue to deteriorate and look to central banks to save them. Are policymakers' guns loaded with blanks?"
It seemed some were already preparing for the worst.
Longer-term U.S. debt rallied hard late in the New York session as investors wagered that either the Fed would be unable to tighten at even a gradual pace, or that if it did hike it would only hasten the arrival of recession and deflation.
In a marked turnaround, yields on 10-year Treasuries fell to 2.673 percent US10YT=TWEB, from an early top of 2.773, almost exactly matching the lowest close from February last year.
That in turn narrowed the spread over two-year paper US2YT=TWEB to just 98 basis points, the smallest gap since late 2007 just before the global financial crisis hit.
Likewise, Fed fund futures <0#FF:> priced in the shallowest of shallow tightening paths. The market implies a rate of 45 basis points for the end of this year, 60 basis points at the end of 2017 and 90 by the close of 2018.
The steady decline in U.S. yields continued to drag on the dollar, which was near its lowest since October against a basket of currencies .DXY.
The yen was again lifted by safe-haven flows, as befits Japan's position as the world's largest creditor nation. The dollar fell to within a whisker of 113.00 yen JPY=, a low not seen since November 2014. It was last at 113.38.
The euro also weakened against its Japanese peer, sliding to a near three-week low of 127.74 yen EURJPY=R. Against the greenback, the euro held at $1.1283 and within reach of a three-month high of $1.13385 set earlier in the week.
The aversion to risk underpinned gold XAU= at $1,199.10 an ounce, not far from Monday's 7-1/2-month high at $1,200.60.
In oil markets, U.S. crude CLc1 slipped 4 cents to $27.41 a barrel, while Brent futures LCOc1 ended Wednesday 52 cents firmer at $30.84.
(Reporting by Wayne Cole; Editing by Shri Navaratnam)
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