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Europe's Debt Woes Return to Haunt Global Markets

The euro slumped to a new 16-month low, taking global stock markets and commodities with it, amid fresh concerns about European banks and the potential for sovereign downgrades.

“I think the market’s primarily concerned about the rollover (of debt) risk from the sovereigns as well as the banks’ capital. You also had weaker European economic data,” said Marc Chandler, chief currency strategist at Brown Brothers Harriman.

Chandler said the concerns are not really new but they have been highlighted in this first week of the year as Italy’s biggest bank, Unicredit, had to offer new shares at a 43 percent discount in order to attract investors.

“On top of that many of the countries were put on credit watch three months ago," Chandler said. "People expect a downgrade any day. Next week, you have Spain and Italy coming to the bond market. Full liquidity hasn’t really returned to the market. The euro is falling against the dollar, and also making new lows against sterling and the yen.”

France also came to market Thursday, selling 8 billion euros of bonds, which saw good demand but at higher yields. The European Financial Stability Fund also sold an oversubscribed 3 billion euros worth of 3-year bonds Thursday.

The euro fell below 1.28 for the first time since September, 2010. Stocks were lower, with the Dow shedding more than 100 points at one point, and commodities also moving lower.

“Things are still highly correlated to the euro. Even though some correlations seem to be softening, we’re still in a world dominated by risk on, risk off, and this is a risk off day,” said Chandler.

There have also been reports of Spain’s banks needing more capital and rumors about other major European institutions needing funds. Hungary, talking to the EU and IMF about a potential back up credit line, is also a point of concern, and its issues are spilling over to Austria, which has large bank exposure to Hungary.

Boris Schlossberg of GFT Forex said the U.S. ISM services report also hit the euro because it dampened some expectations for Friday’s U.S. December jobs number. The employment component of the report was at 49.4, an improvement but still below the expansionary level of 50.

The ISM non manufacturing index rose to 52.6 in December but was less than expected by economists. The ISM report followed weekly jobless claims, which fell to 372,000, a sign of continued improvement in the weak job market. It also came after ADP’s surprise report of 325,000 new private sector jobs in December. That report however, was dismissed as reflecting seasonal hiring.

“You have a perfect storm of issues here,” said Schlossberg. “You have this massive refinancing rollovers from the sovereigns, but you also have a need for the banks to recapitalize because of Basel III requirements.”

As holders of sovereign debt, the banks are exposed if the sovereigns are downgraded, he said. “It’s a flip side of the same coin,” he said.

Schlossberg said the markets could recover losses after the European markets close for the day, as they did on Wednesday.

Follow Patti Domm on Twitter: @pattidomm

Disclaimer

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.