January 2, 2019 / 1:05 PM / 3 months ago

CORRECTED-GLOBAL MARKETS-After brutal 2018, world stocks nurse New Year's hangover

(Corrects paragraph 22 to show 2-10 yield curve flattened last month to tightest in over a decade)

* World shares sag as China factory activity contracts

* US shares set to open weaker, European stocks fall

* Bonds rally, German yields at 20-month lows

* Safe-haven yen, gold rise; copper and oil fall

* US payrolls, Fed's Powell feature later in week

By Sujata Rao

LONDON, Jan 2 (Reuters) - World shares began 2019 on a downbeat note, oil prices and bond yields skidded lower and the Japanese yen strengthened on Wednesday as data from China to France confirmed investors' fears of a global economic slowdown.

The U.S. S&P500 and Dow Jones index futures slipped around one percent and Nasdaq futures fell 2 percent, signalling Wall Street would open in the red on the first trading day of the New Year after closing 2018 with the worst annual loss since 2008.

Weak manufacturing-activity surveys across Asia were followed by disappointing numbers in the euro zone, sending MSCI's index of world shares 0.4 percent lower.

China in particular was in focus, after factory activity contracted for the first time in over two years. The gloom continued in Europe, where the Purchasing Managers' Index for the euro zone reached its lowest since February 2016. Future output PMIs were at a six-year low .

The data suggests there will be no respite for equities or commodities after the 2018 losses.

A pan-European share index recovered some losses to stand 0.6 percent lower. The Paris bourse led losses with a 1.4 percent fall, as France's PMI fell in December for the first time in two years.

"It's a continuation of the worries over growth. You can see them in the Asian numbers, which all confirm that we have passed peak growth levels," said Tim Graf, chief macro strategist at State Street Global Advisors.

The knock-on effects from China's slowdown and global trade tensions were rippling across Asia and Europe, he said.

"I don't think the trade story goes away, and Europe, being an open economy, is still vulnerable," Graf added.

Copper, a key gauge of world growth sentiment, fell to 3 1/2-month lows , while Brent crude futures lost almost 1 percent after shedding 19.5 percent last year .

Commodity currencies' losses were led by the Australian dollar. Often used as a proxy for China sentiment, the Aussie fell as much as 0.7 percent to its lowest since February 2016 .

There were also renewed fears in Europe over the clean-up of Italy's banks, with trading in shares of Banca Carige suspended. Carige failed last month to win shareholder backing for a share issue that was part of a rescue plan. An index of Italian bank shares fell 2.5 percent.

SAFETY FIRST

The stock market rout drove investors into the safety of bonds. Ten-year German Bund yields slumped to 20-month lows of 0.16 percent, their biggest one-day fall in two years.

Gold and the yen benefited too.

While gold topped six-month highs, the yen extended its rally against the dollar to seven-month highs around 108.9 . It strengthened to 19-month peaks against the euro .

"Traditional safe-haven type flows are going into the yen. As we see increased volatility (on world markets), Japanese (investors) are probably repatriating foreign assets," said Charles St Arnaud, senior investment strategist at Lombard Odier Investment Managers.

However, the dollar edged up 0.3 percent against a basket of currencies, rising half a percent to the euro and 0.8 percent versus sterling.

The greenback is under pressure from a fall in U.S. Treasury yields as investors wager the Federal Reserve will not raise rates again. While the Fed itself still projects at least two more hikes, money markets imply a quarter-point cut by mid-2020.

Fed Chairman Jerome Powell may comment on the outlook when he participates in a discussion on Friday, while manufacturing and jobs data due Thursday and Friday should also shed light.

Yields on two-year debt have tumbled to 2.49 percent from 2.977 percent peak in November. Ten-year yields dived to their lowest since last January at 2.647 percent.

The spread between two- and 10-year yields has in turn shrunk, narrowing last month to the smallest since 2007 and heading towards an inversion which has portended recessions in the past.

The German 2-10 yield curve is the flattest since November 2016

"What is clear is that the global synchronised growth story that propelled risk assets higher has come to the end of its current run," OCBC Bank told clients.

"Inexorably flattening yield curves ... have poured cold water on further policy normalisation going ahead."

Additional reporting by Wayne Cole in Sydney and Abhinav Ramnarayan in London Editing by Mark Heinrich

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