LONDON – World share gains stalled and the dollar rose on Thursday as investors grew concerned about political battles looming in Washington over spending cuts, following this week's deal to avoid sharp U.S. tax hikes.
The MSCI world equity index <.MIWD00000PUS> dipped from an 18-month high to be down 0.15 percent at 346.7 points while the dollar hit a three-week peak against a basket of major currencies and oil prices fell.
Share index futures point to a weak start on Wall Street as well after stocks began the new year with their best day in over a year on Wednesday, when relief that lawmakers had reached a deal to prevent a fiscal crunch swept the markets.
President Barack Obama and congressional Republicans now face two more months of tough talks on spending cuts and an increase in the nation's debt limit as the hard-fought deal to avert the "fiscal cliff" mainly covered taxes and delayed decisions on expenditure until March 1.
"Of the three key issues - tax increases, spending cuts and the debt ceiling - policymakers have tackled just one," said Mouhammed Choukeir, chief investment officer at Kleinwort Benson.
"The fiscal cliff issue is unresolved. This is likely to increase market volatility, supporting safe-haven assets such as gold and some commodities," he said. "Paradoxically, as the U.S. debt and deficit issues continue to make investors jittery, the dollar can be expected to remain a safe-haven asset."
The dollar was up 0.3 percent against a basket of major currencies at a three-week high of 80.12 on Thursday, although it slipped 0.4 percent against the yen to 87.14.
The euro, which had touched an 8-1/2 month high against the dollar on Wednesday, was down 0.2 percent at $1.3162,.
"The reality is that budget talks will continue for the next two months and could get sour," said Jane Foley, senior currency strategist at Rabobank. "We see the dollar index reclaiming some ground."
The prospect of more bitter U.S. political battles in the next few weeks over the spending cuts also halted a sell-off in U.S. Treasuries and safe-haven German government bonds.
U.S. benchmark 10-year T-note yields were unchanged at 1.837 percent, while 10-year German cash bond yields were flat at 1.44 percent
Across Europe the main share indexes in Germany , Britain and France were flat to 0.5 percent lower, having hit their own multi-month highs on Wednesday as part of the global rally in riskier asset markets.
The dollar's strength and rising oil supplies pushed crude prices lower, with Brent slipping 0.5 percent to under $112 a barrel. U.S. crude futures were down 53 cents at $92.59.
Analysts expect oil prices to drop in 2013 as supply outweighs demand especially after U.S. crude production hit a 19-year high in 2012 and Russia pumped more oil to remain ahead of Saudi Arabia in production.
Gold followed equities lower to be down about 0.3 percent at $1,681 an ounce.
The precious metal hit its highest level in two weeks on Wednesday in the wake of the initial U.S. fiscal deal adding to gains of around 7 percent in 2012 - its 12th straight annual rise, marking one of the longest bull runs for a commodity.
"The deal to avoid a fiscal cliff has booted some problems into the long grass by a considerable distance, but there are still issues out there such as expanding the debt ceiling, which could prove to be difficult negotiations," said David Jollie, strategic analyst at Mitsui Precious Metals.
GROWTH OUTLOOK EYED
Thursday's retreat across riskier asset markets might have been sharper but for data showing activity in China's services sector and at U.S. factories had expanded in December, brightening the outlook for global growth.
China's official purchasing managers' index (PMI) for the non-manufacturing sector rose to a four-month high in December, adding to signs of a revival in the world's second-largest economy.
Investors will now turn their attention to the December U.S. employment report on Friday. This is expected to show modest job growth of around 150,000 compared with 146,000 in November.
(Additional reporting by Anooja Debnath and David Brough.; editing by David Stamp)