Asian stocks dropped for a second day on Tuesday and Japanese shares hit a one-month low, with investors fretting about the potential economic fallout if the swine virus outbreak becomes a full-fledged pandemic and the results of U.S. bank stress tests.

Futures on the S&P 500 slid 1.5 percent and sparked further selling across Asia after the Wall Street Journal said that U.S. regulators were pushing Bank of America and Citigroup to raise more capital after the initial results of the stress tests.

European stock futures were down between 1.4 percent and 1.8 percent before the start of trade.

More countries have reported cases of the flu, and some such as Australia and South Korea were testing for the virus. The World Health Organization raised its alert level to be a step closer to declaring the first flu pandemic in 40 years.

But so far the deaths have not spread beyond Mexico, where the outbreak began and 149 people have been killed.

Companies such as drugmakers and producers of face masks got a boost on an expected increase in demand, while airlines extended losses on worries the swine flu will cause a sharp reduction in travel around the world.

Japan's Chugai Pharmaceutical <4519.T>, maker of influenza drug Tamiflu, rose 1.9 percent. Hong Kong's Cathay Pacific Airways <0293.HK> dropped 3 percent.

Market players cut back on holdings of riskier higher-yielding currencies and commodities for a second day, taking profits on winning bets since the beginning of March on hopes a global economic recovery was taking root.

Active trade is limited as the market is trying to grasp how much swine flu could impact the global economy. We had finally begun to see a bottom for the global economy and that has been now ruined by pigs, said Tsuyoshi Segawa, equity strategist at Shinko Securities.

The MSCI index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> fell 2.2 percent after the S&P 500 <.SPX> shed 1.1 percent on Monday.

The MSCI benchmark for Asia is still up 28 percent from its lows in early March, which took it near a five-year low struck last November.

Japan's Nikkei average <.N225> shed 2.7 percent, with disappointing earnings from shippers like Mitsui OSK Lines <9104.T> and steelmakers like Nippon Steel <5401.T> slamming the market.

AUSSIE AND KIWI EXTEND SLIDE

The Australian and New Zealand dollars -- still among the highest-yielding of major currencies -- hit one-month lows against the yen as investors cut back on traditional plays favoring carry trades that were in vogue as stocks rallied.

The Aussie was down 1.8 percent against the yen at 67.30 yen and shed 1 percent against the dollar to $0.7021. The kiwi shed 2.5 percent against the yen.

Between early February and mid April, the Aussie had surged more than 30 percent against the yen as carry trades -- using low-yielding currencies as a cheap source of funds to buy higher-yielding currencies -- came back into favor.

The Aussie's correlation has been strengthening against key stock markets over the past few weeks, suggesting that investors have been cutting positions at the same time across markets.

The dollar was steady after posting gains the previous day as investors park funds in the U.S. currency as a haven while shedding holdings of riskier assets.

The dollar index, a gauge of its performance against six major currencies, was flat at 85.677 <.DXY> after having jumped 1.1 percent on Monday -- the biggest daily rise in a month.

The dollar's gains pushed gold prices lower and triggered stop-loss selling of bullion, traders said. Gold was down $10.20 an ounce at $896.30. U.S. crude oil shed 89 cents to $49.25.

Government bonds jumped as equity market losses accelerated.

Japanese government bond futures rose 0.63 point, the biggest daily gain in a month and boosted in part by market players covering short positions.

Safe-haven Treasuries gained, with benchmark 10-year notes edging up 5/32 in price to yield 2.893 percent, off 2 basis points from late U.S. trade.

(Additional reporting by Aiko Hayashi in Tokyo; Editing by Neil Fullick)

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