European stocks hit three-week low as Trump reality sets in

By Abhinav Ramnarayan

LONDON (Reuters) - European stocks and bond yields dropped on Monday and the dollar hit a six-week low after U.S. President Donald Trump began his term in office with a protectionist speech that pushed a nervous market into safe-haven assets.

World stocks hit multi-year highs earlier this month on expectations Trump would boost growth and inflation with extraordinary fiscal spending measures.

However, his inaugural address on Friday saw investors retreat to the safety of higher-rated government bonds as the new president signalled an isolationist stance on trade and other issues.

He also made it clear that he plans to hold talks with the leaders of Canada and Mexico to begin renegotiating the North American Free Trade Agreement.

European stocks fell 0.7 percent and the broader Euro STOXX 600 fell 0.6 percent in early trades on Monday, both hitting their lowest level this year so far.

Japan's Nikkei .N225 dropped 1.1 percent while shares in Australia dropped 0.8 percent after Trump's administration also declared its intention to withdraw from the Trans-Pacific Partnership (TPP), a 12-nation trade pact that Japan and Australia have both signed.

Other Asian shares were more resilient, however, in part due to the dollar's weakness, and MSCI's broadest index of Asia-Pacific shares outside Japan rose 0.3 percent.

"The focus this morning is on the protectionist rhetoric and the lack of detail on economic stimulus, so it's a nervous start (to the presidency)," said Investec economist Victoria Clarke.

"The other concern is how the Fed interprets Trump's stance, the worry being the less he does on fiscal stimulus the more nervous they may get on pushing the rate hikes through."

The U.S. Federal Reserve, which has indicated that it expects to raise its benchmark interest rate three times this year, is due to hold its next meeting on Jan. 31 and Feb. 1.

Rabobank analyst Michael Avery said a more protectionist United States could lead to a U.S. dollar liquidity squeeze, with Mexico and Asia likely the most badly hit.

"We would see outright confusion over what currency to invoice, trade, and borrow in: a 19th century world of competing reserve currencies in different geographic zones, but without the underpinning of gold," Avery said in a note.

The problem would be exacerbated if China tightens capital controls further, he said.

The U.S. dollar fell 0.5 percent against a basket of six major currencies and as much as 1 percent against the Japanese yen.

The nervous start on Monday saw safe haven assets in demand.

The yield on Germany's 10-year government bond, the benchmark for the region, led most euro zone bonds lower, dropping 4 basis points to 0.32 percent in early trade.

This followed 10-year U.S. Treasuries yields, which fell to 2.43 percent, after having risen briefly on Friday to 2.513 percent, its highest since Jan. 3.

Spot gold prices, meanwhile, rose on Monday to their highest in two months.

(Additional reporting by Hideyuki Sano; Editing by Hugh Lawson)