Asian shares slid on Friday after a Republican proposal to deal with a U.S. fiscal crunch failed to get enough support, deepening uncertainty over the U.S. can avert the "fiscal cliff" of automatic spending cuts and tax increases set to start January 1.
"Markets disliked signs of further delay in talks, with the risk that a deal may not be reached by the end of the year deadline," said Yuji Saito, director of foreign exchange at Credit Agricole in Tokyo. "It clearly hit risk sentiment."
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The U.S. House of Representatives will adjourn until after Christmas, Republican Representative Peter Roskam said on Thursday, after House Speaker John Boehner's proposed tax bill designed to avert the fiscal cliff failed to pass.
U.S. stock index futures fell sharply. S&P 500 stock futures slipped 1.7 percent, while Dow Jones stock futures and Nasdaq futures both lost 1.5 percent.
European shares will likely drop also, with financial spreadbetters predicting London's FTSE 100 , Paris's CAC-40 and Frankfurt's DAX will open down as much as 0.6 percent.
The worrying U.S. political news sparked selling in Asian shares, with MSCI's broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> wiping out earlier gains to tumble 0.7 percent. The index was on track to end the week down 0.6 percent, the first weekly loss in five weeks.
Markets broadly had been supported by optimism that U.S. lawmakers would avoid the fiscal cliff, which threatens to derail the U.S. economy and drag down global growth with it.
Boehner's proposal was aimed at extracting concessions from the White House, which had threatened to veto it, and advance talks closer to a deal.
The Republican-led U.S. House of Representatives, which abruptly recessed on late Thursday, may return as soon as December 27 with a yet-to-be-decided new plan, said a senior party aide.
"This is a major setback for a Fiscal Deal compromise between the two parties. I would say that chances of a deal are down to maybe 40 percent from 65 percent -- despite the dysfunction in Washington D.C," said Douglas A. Kass, founder of hedge fund Seabreeze Partners Management Inc.
Risk assets were sold off, from shares, oil to currencies such as the Australian dollar and the euro. The yen firmed slightly, though it was pinned near multi-month lows versus the dollar and the euro on expectations for more aggressive Bank of Japan easing next year to drive the economy out of deflation.
"The delay in resolving the U.S. fiscal cliff problem is raising concern as the market expected some sort of positive direction out of the talks by the end of the year," said Fujio Ando, a senior managing director at Chibagin Asset Management.
Safe-haven government bond prices rose, with U.S. 10-year Treasury yields moving away from an 8-week high hit this week, falling about 6 basis points to 1.74 percent. Benchmark 10-year Japanese government bond yields also ticked down half a basis point to 0.765 percent.
Inflows into U.S. Treasuries underpinned the U.S. dollar, which inched up 0.1 percent against a basket of major currencies .
Jim Barnes, senior fixed income manager at National Penn Investors Trust Co. in Wyomissing, Pennsylvania, saw Treasuries continuing to gain once U.S. markets open later, but expected a correction by the end of the day.
"Treasury yields will likely fall Friday morning and will begin to reverse course in the afternoon as investors become more optimistic a deal will be reached," Barnes said.
"So far, the market has been handling setbacks in negotiation talks very well. With still a little bit of time left on the clock, this time around will be no different."
Asset performance in 2012: http://link.reuters.com/muc46s
U.S. GDP: http://link.reuters.com/guw34t
Along with uncertainties surrounding the future of U.S. budget talks, a firmer dollar also weighed on dollar-based commodities.
The euro fell 0.3 percent to $1.3206, off an 8-1/2-month high of $1.33085 touched on Wednesday.
U.S. crude futures dropped more than $1 to $89.10 a barrel, but oil was still on track for its biggest weekly gain since August.
Spot gold extended losses to near a four-month low touched on Thursday, and was last down 0.1 percent to $1,644.90 an ounce. Gold remained on course for a 12th annual growth on rock-bottom interest rates, concerns over the euro zone financial stability and diversification into bullion by central banks.
YEN GAINS SLIGHTLY
Anxieties over the U.S. budget negotiations also took their toll on Japan's Nikkei average <.N225>, which had been supported by a weaker yen. The Nikkei gave up all of earlier gains to close down 1 percent and below the key 10,000 mark it reclaimed for the first time since early April on Wednesday.
The dollar was down 0.4 percent to 84.02 yen, moving away from a 20-month high of 84.62 yen hit on Wednesday.
The euro slumped 0.7 percent to 110.91 yen also off a 16-month high of 112.59 yen reached on Wednesday.
The yen was kept under pressure after the Bank of Japan further eased monetary policy as expected on Thursday, with investors anticipating that the central bank will be persuaded to pursue more drastic measures next year.
The incoming prime minister, Shinzo Abe, has called for bolder action by the central bank to help bring Japan out of decades-long deflation.
For all the fears of a fiscal cliff debacle to come, several data series showed the United States remained on a recovery track, helping to underpin the dollar.
(Additional reporting by Masayuki Kitano in Singapore, Jennifer Ablan in New York and Ayai Tomisawa in Tokyo; Editing by Richard Borsuk)