World shares stalled near 18-month highs and safe-haven U.S. Treasuries rose on Tuesday as a looming battle in Washington over the government's borrowing limit and a recovery in the Japanese yen eased demand for riskier assets.
Investors became more cautious as a refusal by Congress to increase the $16.4 trillion ceiling would raise the risk that the United States could default on its debt by the spring.
A warning from Federal Reserve Chairman Ben Bernanke over the economic impact of any failure to agree a higher ceiling, a Treasury prediction the limit could be hit by mid-February, and President Barack Obama's tough negotiating stance combined to subdue markets which have gained since the New Year.
"Fault lines have become visible again, warning investors that there will be tough negotiations to come, leaving risky assets vulnerable to a correction," said Hans Redeker, head of currency strategy at Morgan Stanley.
The MSCI world equity index, hovered near an 18-month high at 350.4 points, up just 0.1 percent on the day. Europe's FTSE Eurofirst 300 index of top shares was also little changed at 1,159.99 points.
Data showing the German economy contracted by a larger-than-expected 0.5 percent in the final quarter of 2012, as the euro zone crisis weighed on exports and corporate investment, added to the concerns in European markets.
London's FTSE 100, Frankfurt's DAX and Paris's CAC-40 were all little changed.
Morgan Stanley's Redeker said separate comments by Bernanke on Monday that the Fed was closely monitoring the impact of its asset buying programme had also weakened the assumption of many investors that assets such as equities were a one-way bet.
"We are moving away from a super positive environment to a less positive one," he said.
World share markets and corporate bonds have risen sharply this year on a widely-held view that the supportive monetary policies of the Fed will boost the U.S. economic recovery while keeping returns on safe haven assets such as Treasuries low.
In the foreign exchange market Bernanke's comments prompted some selling of the dollar though the falls were exacerbated against the yen when a Japanese minister warned about the negative effect of excessive currency weakening.
Japan's currency has been falling steadily since a new government, elected in December, moved to boost spending and put pressure on the Bank of Japan to ease its monetary policy aggressively to help lift the economy out of recession
However, Economics Minister Akira Amari said on Tuesday that if the yen fell too far it could hurt people's livelihoods by raising import prices.
The dollar dropped about 0.8 percent to 88.75 yen although it was steady against a basket of major currencies.
"That the yen's weakness has its downside for Japan is something the market has almost completely ignored until now," said Daisuke Uno, chief strategist at Sumitomo Mitsui Banking Corp.
Bernanke's comments and the debt ceiling concerns pushed 10-year U.S. Treasuries 4/32 in price to yield 1.833 percent , just above Monday's low of around 1.831 percent, its lowest level in about 1-1/2 weeks.
Spanish and Italian bond yields reversed an earlier rise on Tuesday after strong bidding emerged at debt auctions by the two countries. Spanish 10-year yields were at 5.04 percent , having risen as high as 5.14 percent earlier while equivalent Italian yields were 2 basis points lower at 4.17 percent.
Peripheral European sovereign bond yields have fallen since late last week when the European Central Bank decided to leave interest rates at a record low of 0.75 percent, citing an improving economic outlook across the region.
Gold rose by over 1 percent on Tuesday to top $1,680.50 per ounce, taking a cue from Bernanke's comments that suggested the central bank was in no hurry to withdraw monetary stimulus.