China rout, oil gloom deepen losses in shares

Japan's Nikkei fell 2.4 percent while Hong Kong's Hang Seng Index declined 2.3 percent, with MSCI's broadest index of Asia-Pacific shares outside Japan falling 1.5 percent after two days of gains since late last week.

Mainland Chinese shares slumped more than six percent to a 14-month low in another sign that authorities in Beijing have their work cut out in their efforts to stabilise the fickle domestic markets.

European shares are expected to follow suit. Spreadbetters are expecting Britain's FTSE and France's CAC 40 to fall by as much as 0.8 percent and Germany's DAX to drop 0.7 percent.

"Wherever you look - China, oil and the U.S., there is no clear evidence of improvement in economic fundamentals. So in the near term, it is hard to expect risk asset prices to gain further after a spate of short-covering," said Tatsushi Maeno, managing director at PineBridge Investments.

Crude oil prices have tumbled around 7 percent so far this week as top producers show no sign of cutting production.

The chairman of Saudi Aramco said on Monday the firm is continuing to invest in oil and gas production capacity, despite cost-cutting because of low oil prices.

Iraq's output reached a record last month and a senior Iraqi official said Iraq may raise output further this year.

Oil prices have fallen more than 75 percent from their 2012 peaks as global output was boosted by U.S. shale oil production and demand growth turned tepid, partially caused by the Chinese economy's slowing growth. The massive price fall is putting huge pressure on profitability of energy firms worldwide, which are in turn slashing investment and cutting jobs.

The U.S. S&P fell 1.6 percent to 1,877.08, led by a 4.5 percent drop in the energy sector.

Brent crude futures, the global benchmark, dropped to $30 a barrel, falling 2.1 percent in Tuesday Asian trade, or 7.2 percent so far this week.

Financial shares were also badly hit as investors grew concerned about their heavy lending to the energy sector.

U.S. financial shares in fact have fallen 12.8 percent so far this year, more than the energy sector's 11.2.

Countering selling pressure for now are vague hopes that the U.S. Federal Reserve may tone down its bias towards further policy tightening and that the Bank of Japan may expand its stimulus. Both will hold policy reviews this week.

The U.S. Federal Reserve's policy statement is due on Wednesday followed by the Bank of Japan's announcement on Friday.

Fed officials have so far stuck to the line that the bank would be ready to raise interest rates four times this year, despite market volatility, as the U.S. economy continues to grow.

Investors have difficulty believing such a policy tightening is possible under the current unstable economic and market conditions, with federal fund rate futures pricing in just over one rate hike this year.

Some investors hope a more dovish tone out of the Fed meeting would help to soothe market sentiment, given that the perception gap between markets and policymakers has been a major source of anxiety.

Speculation that the Bank of Japan could step up its stimulus this week is also rising, although many market players still think the BOJ will hold fire for now.

The rebound in oil and risk assets late last week was indeed spurred by comments from European Central Bank President Mario Draghi indicating another stimulus in March.

"The fall in markets is stemming from worries about China, oil and so on. And now people think policymakers will try to stop that with monetary easing," said Koichi Yoshikawa, executive director of finance at Standard Chartered Bank.

"The problem is that monetary easing has succeeded in supporting financial markets but not necessarily the real economy," he added.

In currencies, resurgent risk aversion helped to lift the yen to 117.99 to the dollar from its two-week low of 118.88 hit on Friday.

The euro also gained against the dollar to $1.0845, 0.5 percent above levels late last week and recovering about half the losses seen on Thursday when European Central Bank President Mario Draghi indicated more stimulus in March.