* Shanghai rebar, Dalian iron ore fall more than 4 pct
* Volatility in ferrous futures affecting physical prices
* Even as seasonal steel demand in China is picking up (Updates prices)
By Manolo Serapio Jr
MANILA, March 22 (Reuters) - Chinese steel and iron ore futures fell sharply for a second straight session on Wednesday as investors continued to cash in on recent gains even as the outlook in the physical market was supported by a seasonal pickup in demand.
The losses in both commodity futures came after they posted their largest weekly increases in two months last week, and traders say the wild swings in the futures market have unnecessarily swayed the physical market.
As futures slid, spot iron ore on Tuesday tumbled more than 4 percent, its steepest single-day drop in more than three months.
“A lot of speculative players in the paper market create volatility in the price and this volatility has affected the physical market,” said an iron ore trader in Shanghai.
“Fundamentals have not changed so much. Seasonal demand is still happening because the temperature in most areas in China is warm enough for construction projects to proceed.”
The most-active rebar on the Shanghai Futures Exchange closed down 4.7 percent at 3,117 yuan ($453) a tonne.
Iron ore on the Dalian Commodity Exchange slipped 4.4 percent to end at 665.50 yuan per tonne.
Earlier in the session, both commodities touched their lowest since March 13.
But Morgan Stanley said declining inventory at both Chinese traders and mills “suggest rising demand”.
Steel stocks at traders dropped 2.5 percent as of March 17 from the previous week, while those at major mills dived 8.3 percent on Feb. 28 from Feb. 20 onwards, Morgan Stanley stated in a report.
Further weakness in futures could drag down spot iron ore prices again as prospective buyers pare down bids for physical cargoes, traders said.
Iron ore for delivery to China’s Qingdao port .IO62-CNO=MB slid 4.3 percent to $87.59 a tonne on Tuesday, the lowest since March 10, according to Metal Bulletin.
It marked the largest drop for the spot benchmark since December 2016. ($1 = 6.8847 Chinese yuan) (Reporting by Manolo Serapio Jr.; Editing by Sherry Jacob-Phillips)