Stocks, dollar sag as data points to flagging US economy

By Amanda Cooper

LONDON (Reuters) - Global shares eased on Tuesday as investors considered the prospect that the U.S. economy's "exceptionalism" may be starting to unwind as manufacturing activity there further weakened, in turn pushing the dollar to multi-month lows.

In India, share markets sold off sharply after early vote counting showed Prime Minister Narendra Modi's Bharatiya Janata Party (BJP)-led alliance was not headed for a landslide win as predicted.

The dollar skimmed its lowest in over two months against the euro and the pound, while U.S. government bond yields have retreated over the past six weeks, as investors have bought into the idea that the economy is slowing enough to warrant rate cuts this year.

"It is understandable why the market behaved as it did in the first quarter, but if one looked at broader indicators, there have always been certain signs that maybe the story isn't quite as strong as might have been expected," Daiwa Capital economist Chris Scicluna said.

"Most people would have assumed that where the fed funds rate is right now is in restrictive territory. That is bearing down on underlying inflation and bearing down on some of the dynamism in spending," he said.

The MSCI All-World index was last down 0.2%. Stocks in Europe also took a breather, pushing the STOXX 600 lower for the first time in four days, down 0.5%.

U.S. stock futures, the S&P 500 e-minis, were down 0.2%, suggesting a modest decline at the open on Wall Street.

Indian equity markets witnessed volatile trade, as vote-counting suggested Modi's party would secure a majority, but one smaller than exit polls had suggested.

A Modi victory had been expected to be positive for the country's financial markets, according to analysts, on the hope India will undertake further economic reform.

The reduced prospect of Modi's alliance winning an overwhelming majority rattled investors.

The Nifty index dropped as much as 8.5% before recovering some of those losses, while BSE index dropped was down 5%. Both indexes had touched all-time highs on Monday.

JOBS, JOBS, JOBS

This week brings a slew of major data. The strength of the U.S. labour market will be closely watched in the new few days with the Job Openings and Labor Turnover Survey (JOLTS) due to be published later on Tuesday. Non-farm payroll figures for May are out on Friday.

"We're expecting a slight easing in demand for labour in the U.S. market," said Raisah Rasid, JPMorgan Asset Management's global market strategist.

"What does that mean for the Fed? I think all data points to one interest rate cut later in the year, potentially in December. If the data moves quicker than expected that cut could be moved forward to September."

On Monday, U.S. Treasury yields fell to the lowest point in two weeks, after the country's manufacturing activity slipped for the second consecutive month in May.

The yield on benchmark 10-year Treasury notes fell 2 basis points to 4.381%, while the two-year yield, which rises with traders' expectations of higher Fed fund rates, fell 1 bps to 4.8058%.

"The sharper move at the long-end is a sign that weaker manufacturing data is unlikely to shift the dial on Fed rate cuts near term, but is perhaps a signal of the market's view of neutral interest rates as US economic exceptionalism fades," Westpac economist Jameson Coombs said in a note on Tuesday.

In Europe, investors expect the European Central Bank on Thursday to cut the benchmark rate by 25 basis points to 3.75%.

The dollar fell 0.4% against the yen to 155.39, around its lowest for two weeks and nearly 3% down from late April's multi-year high at 160.03.

The euro was down 0.2% on the day at $1.0881, having gained 0.65% in a month, while the dollar index, which tracks the greenback against a basket of currencies of other major trading partners, held around 104.

U.S. crude fell 1.8% to $72.88 a barrel. Brent crude fell 1.6% to $77.10. Both benchmarks hit four-month lows on Monday after the Organization of the Petroleum Exporting Countries and allies, together known as OPEC+, agreed to start unwinding some production cuts from October.

Gold was slightly lower, falling 0.6% to $2,335 an ounce.

(This story has been corrected to remove 'in different direction' from a quote in paragraph 14)