By Koh Gui Qing

NEW YORK (Reuters) -Global stock markets swooned on Friday as fears about contagion among banks hobbled shares of lenders such as Deutsche Bank, with the flight from risk shoring up the dollar and driving bond yields lower.

Market sentiment was hurt by a sell-off in Deutsche shares, which tumbled as much as 15%, as its credit default swaps, which reflect the cost of insuring debt against the risk of non-payment, shot to their highest in more than four years.

“The growing sense of unease about the global banking system is heightening volatility in stock markets around the world,” said Nigel Green, chief executive of deVere Group, a financial advisor.

The failure of U.S. regional banks Silicon Valley Bank and Signature Bank this month triggered fears of a banking contagion and prompted U.S. Treasury Secretary Janet Yellen on Thursday to pledge action to safeguard bank deposits.

“As concerns about the stability of banks persist, we expect further and intensifying market volatility,” Green said.

The Dow Jones Industrial Average reversed earlier losses to end up 0.41%, the S&P 500 added 0.56%, and the Nasdaq Composite Index rose 0.31%.

JP Morgan Chase dropped 1.52%, the S&P 500 banks index was down 0.33%, while the KBW regional bank index climbed 2.92%.

In Europe, the STOXX 600 index fell 1.37%, helping to drag the MSCI World share index down 0.21%.

A STOXX sub-index of bank shares, which has swung wildly this week as traders debated if a forced weekend tie-up between Credit Suisse and UBS was a mark of stability or incoming systemic stress, dropped 4.64%, heading for its third consecutive week of declines.

Deutsche, which had announced plans on Friday to redeem $1.5 billion of tier 2 debt not due to be repaid until 2028, slumped 8.5%. For the month so far, Deutsche has shed 27.6%.

The moves highlight just how frail sentiment remains after turmoil in the U.S. and European banking sectors in the past two weeks have revived memories of the 2008 global financial crisis.

Yellen has this week tried to assuage fears about the health of U.S. lenders and the economic ramifications of a potential lending crunch if depositors flee smaller banks, which have outsized roles in supporting key sectors such as commercial real estate.

“I don’t expect this volatility (in bank stocks) to subside anytime soon,” said Peter Doherty, head of investment research at private bank Arbuthnot Latham in London.

Doherty said issues of “contagion risk within the U.S. banking sector” were undoubtedly weighing on appetite for bank stocks elsewhere.

Stronger demand for safe-haven assets, and bets that the Federal Reserve will soon pause its policy tightening cycle due to the banking turmoil, pushed the two-year U.S. Treasury yield, which tracks interest rate expectations, down about 3.5 basis points to 3.7709%. [US/]

Traders have also priced in U.S. rate cuts of about 90 bps basis points to about 3.9% by the end of the year.

Euro zone government bond yields followed Treasury yields lower, with two-year German yields dropping a hefty 25 bps to 2.25%.

In currencies, the dollar reversed a losing streak to gain 0.49% against major peers as risk aversion strengthened appetite for the reserve currency.

The Japanese yen, a safe haven currency, was steady at 130.705 after hitting a six-week high of 129.8 per dollar. The euro fell about 0.6% to $1.07620.

Brent crude, the global oil benchmark, fell 1.2% to $74.99 per barrel, as banking sector concerns dimmed the outlook for energy demand.[O/R]

A firmer dollar dragged on gold prices, though they were still on track to end higher for the week, for the fourth consecutive week, as bank contagion worries and bets about a pause in Fed rate hikes bolstered the appeal of non-yielding bullion. [GOL/]

Spot gold lost 0.82%, at $1,977.2 per ounce.

The Fed raised its main interest rate by a quarter point to a range of 4.5%-4.75% on Wednesday, but signalled it would consider a pause in light of banking system stresses.

Markets, however, are betting on a U.S. recession and incoming rate cuts.

“You could have a period where you see a precipitous drop in the (availability of) credit in the U.S.,” said Arun Sai, senior multi-asset strategist at Pictet Asset Management. “This takes us closer to a hard landing, to a U.S. recession.”

(Reporting by Naomi Rovnick; Additional reporting by Stella Qiu and Chiara Elisei; Editing by Susan Fenton, Jonathan Oatis, William Maclean and Richard Chang)

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