By Rodrigo Campos
NEW YORK (Reuters) - Emerging market equities posted their largest drop in five months on Monday to lead a global stocks sell-off, while Wall Street pared early gains as sentiment continued to sour.
Concerns about China's economic slowdown and its shadow banking sector, combined with expectations that the U.S. Federal Reserve will scale back its bond buying further, have put pressure on emerging markets dependent on external financing.
Political risks in Ukraine, Turkey and Thailand, as well as a looming financial crisis in Argentina, are compounding the problem of emerging markets in a week when the Fed is expected to cut its monthly bond purchases by another $10 billion.
The Turkish lira edged back from record lows, however, after the central bank announced an emergency policy meeting, raising market hopes that it would ignore political pressure and implement a decisive rate hike to protect its currency.
The yen and the Swiss franc gave back part of last week's gains against the U.S. dollar, which also benefited from expectations the Fed may reduce monetary stimulus this week.
On Wall Street, strong earnings from Caterpillar were the focus at the open, but a bounce higher was more than offset by weaker-than-expected December home sales data.
"Earnings gave investors hope but the reality of all the moving parts of emerging markets and weak home sales made them rethink how good results from a handful of companies really are," said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh.
She said investor concern highlighted the complexity of global markets. "This is a clockwork mechanism and when the tiniest thing goes wrong, the clock stops working; it's not well understood, and it has all these unintended consequences."
The Dow Jones industrial average was up 24.60 points, or 0.15 percent, at 15,903.71. The Standard & Poor's 500 Index was down 4.15 points, or 0.23 percent, at 1,786.14. The Nasdaq Composite Index was down 35.07 points, or 0.85 percent, at 4,093.10.
MSCI's world equity index fell 0.8 percent following Asia's decline of 1.5 percent. The FTSEurofirst 300 index of top European stocks was also down 0.8 percent.
China's shadow banking sector, a key source of financing for local corporations, was under the spotlight.
A Chinese trust firm said it had reached an agreement to resolve a troubled high-yield investment product, just days away from what could have been a precedent-setting default in China's shadow banking system.
EMERGING MARKETS DEJA VU
Emerging markets experienced a similar synchronized sell-off last May when the Fed initially suggested a wind-down to its stimulus. But this time, local factors are playing a bigger role.
"The question is one of contagion and risks, and that's what we're living through at the moment. You can see the source of the problem is not somewhere else but directly in emerging markets. That's really worrying the market," said David Bloom, head of currency strategy at HSBC.
The Turkish lira, which has been leading the rout in emerging currencies amid a corruption scandal that has rocked Prime Minister Tayyip Erdogan's government, hit a record low of 2.39 to the dollar before regaining some ground after the central bank said it would hold an emergency meeting on Tuesday.
The yen hit a seven-week high of 101.77 per dollar before falling 0.2 percent to 102.49 per dollar.
Following its fifth-straight week of gains, spot gold also fell, down 0.6 percent to $1,261 per ounce.
The 10-year U.S. Treasury yield traded near a two-month low of 2.706 percent hit Friday. Benchmark 10-year Treasuries notes were unchanged in price to yield 2.735 percent.
(Reporting by Rodrigo Campos; Editing by Dan Grebler)
