Markets remained under pressure Friday as budget discussions between President Barack Obama and congressional leaders got underway and as investors fretted over a military escalation in Gaza.
Japanese stocks, however, enjoyed solid gains on hopes that elections next month may lead to more stimulus measures being enacted, in the latest attempt to get the stuttering economy moving.
Over the past couple of weeks, a combination of factors has turned sentiment in the markets sour. As well as ongoing concerns over Europe's debt crisis, investors have grown worried about the state of the U.S. public finances and rising tensions in the Middle East as attacks continue and Israeli troops mass near Gaza — a possible signal that a ground invasion might be imminent.
In Washington, Obama and the Republican-controlled House of Representatives have to thrash out a budget deal soon to avoid the so-called 'fiscal cliff' at the start of next year — a series of automatic tax rises and spending cuts that will come into force if an agreement is not reached. Some economists estimate that could cut around 5 percentage points off U.S. growth, plunging the world's largest economy into recession and seriously derailing the global economy.
"While the early rhetoric from political leaders has indicated a willingness to be flexible, there is still a gap between the President and Republicans on the mix of tax increases and spending cuts that will be needed to reach a deal," said Nick Bennenbroek, an analyst at Wells Fargo Bank. "Wariness over the outcome of these initial talks is probably the main reason for market caution."
In Europe, the FTSE 100 index of leading British shares was down 0.9 percent at 5,630 while Germany's DAX fell 0.7 percent to 6.991. The CAC-40 in France was 0.5 percent lower at 3,367.
In the U.S., the Dow Jones industrial average was down 0.3 percent at 12,502, while the broader S&P 500 index fell 0.4 percent to 1,347.
In the risk-averse trading environment, the dollar garnered some support through its supposed status as a safe haven financial asset. The euro was 0.6 percent lower at $1.2713.
Trading in Asia was similarly subdued. Hong Kong's Hang Seng rose 0.2 percent to 21,159.01 but South Korea's Kospi fell 0.5 percent to 1,860.83.
Benchmarks in China fell, with the Shanghai Composite Index closing 0.8 percent lower at 2,014.72 while the Shenzhen Composite Index fell 0.7 percent to 800.20.
Japan's Nikkei 225 stock index jumped 2.2 percent to close at 9,024.16, rallying for a second straight day on expectations that the opposition Liberal Democratic Party may win elections next month and pursue more aggressive stimulus policies than the current leadership. Prime Minister Yoshihiko Noda dissolved the lower house of parliament Friday, paving the way for elections in which his ruling party will likely give way to a coalition government.
"Equity markets in Japan have taken heart from the decision to call a snap election, with the LDP opposition promising more aggressive support for the economy," said Rebecca O'Keeffe, head of investment at Interactive Investor.
Japan's exporters, whose fortunes are linked to the yen's valuation, were buoyed by the prospect of a changing of the guard. Mazda Motor Corp. soared 7.1 percent. Nissan Motor Co. jumped 5.1 percent. Nikon Corp. surged 7.2 percent and Canon Inc. gained 5.8 percent.
The yen has also recovered its poise after two days of selling, with the dollar down 0.2 percent at 81.10 yen.
Oil prices were volatile as investors monitored fighting between Israel and militants in Gaza and its potential impact on supplies. After an earlier retreat, the benchmark New York rate was up 81 cents at $86.68 a barrel.