Shaken by Europe's liquidity withdrawals

Global sharemarkets are again showing signs of extreme bipolar behaviour, with investors dumping the 'risk' assets that have been so prized in recent months, and instead flocking to the safety of US and German bonds.

The trigger for the reversal was the rise in Spanish interest rates, with the yield on 10-year bonds soaring to almost 6 per cent overnight. Most economists believe this level is unsustainable, because it pushes Spain's borrowing costs to prohibitive levels. Investors are now worried that Spain is trapped in a vicious circle, where soaring borrowing costs make it near impossible for the country to reduce its gaping budget deficit.

Earlier this week, the centre-right government of Mariano Rajoy – which is under intense pressure to cut the Spanish budget deficit to 5.3 per cent of GDP this year from 8.5 per cent of GDP last year – announced plans to save a further €10 billion by improving efficiency in the health and education sectors. But investors are sceptical that these savings can be achieved, because Spain's 17 autonomous regions control schools and hospitals, rather than the central government.

Spain's IBEX 35 stock index reflected investors' gloom, falling 3 per cent to its lowest close in three years. Spanish bank shares were also hard hit, with banking giant Banco Santander falling by 3.9 per cent and BBVA by 3.6 per cent, after the head of Spain's central bank warned that the country's banks might need more capital if the country's economy continued to deteriorate.

Worries over the Spanish economy rippled through other European sharemarkets.

In Paris, the CAC 40 dropped 3.08 per cent to hit its lowest level since January 13. Bank stocks bore the brunt of the selling, with BNP Paribas falling 5.7 per cent, Crdit Agricole down 3.2 per cent, and Socit Gnrale falling 6.2 per cent.

It was a similar story in Frankfurt, where heavy losses in financial stocks dragged the DAX down by 2.5 per cent. Commerzbank dropped 5.9 per cent, while Deutsche Bank was 4.2 per cent lower.

Investors are now concerned that the effects of the European Central Bank's ‘monetary morphine' – the €1 trillion in cheap three-year loans it provided to European banks – are wearing off. And they're worried that ECB boss, Mario Draghi, who recently stressed the need for governments to speed up their reform efforts, might be reluctant to buoy the market mood by supplying banks with another large liquidity injection.

Overnight, the boss of Banco Santander, Alfredo Senz, urged the ECB to step up its liquidity injections and to buy more Spanish government and bank bonds.

"It should be a little more aggressive in its monetary expansion and be more aggressive in purchases of public and private bank debt,” Senz told a banking conference in Madrid. "It would have to do a stronger policy of European quantitative easing.”

A weaker global growth outlook, following Friday's disappointing US employment report, and the latest Chinese trade figures which fuelled fears of a slowing Chinese economy, also weighed on the market mood.

Dejected investors sought refuge in traditional 'safe' investments, such as US and German bonds. As a result, yields on US 10-year bonds again dipped below 2 per cent, while yields on 10-year German bunds fell to 1.64 per cent, close to September's all-time low of 1.63 per cent.