Asian shares rose and the euro steadied on Tuesday, keeping gains from the previous day as investors grew more confident about European leaders coming to a broad agreement to contain the region's debt crisis.
European policymakers neared a deal over the weekend on bank recapitalization, and France and Germany appeared close to agreement on how to use the European Financial Stability Facility (EFSF) to stave off contagion in the bond market.
But final decisions were deferred until a second summit scheduled for Wednesday, putting a cap on markets.
Deep divisions over the extent of losses that private holders of Greek bonds would have to incur remain a huge risk, putting downward pressure on the markets.
Investors are also concerned that the size of the bail-out fund, the EFSF, may not be sufficient to stem the debt woes from spreading wider.
A lot has already been priced in, so profit-taking flows will likely set initially and put downward pressure on the market after Wednesday, before the market consolidates, said Frances Cheung, senior strategist for Asia ex-Japan at Credit Agricole CIB in Hong Kong.
Sentiment was boosted after the world's largest heavy equipment maker Caterpillar Inc
Its stock gained 5.5 percent on the New York Stock Exchange and further upbeat forecast from General Electric Co
The markets, particularly commodities, were also encouraged by comments from William Dudley, president of the New York Federal Reserve Bank, that another round of quantitative easing, or QE3, is one possible option the U.S. central bank has to boost the slow recovery.
With some direction emerging from Europe on its debt crisis, there is a feeling the worst can be avoided, spurring an unwinding of an excessive risk aversion, which may continue in the very near-term, said Tetsuro Ii, president of Commons Asset Management in Tokyo.
Money is flowing into commodities, and speculation about QE3 is definitely helping the mood.
But over the medium-term, markets will be firmly capped by the European debt crisis.
What will be agreed on Wednesday will be just the start, Ii said. It will address the macro issues, but micro issues, problems facing individual countries must be tackled next, so we can't be optimistic.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> rose 0.3 percent, with the metals <.MIAPJMT00PUS> and energy <.MIAPJEN00PUS> sectors leading the gains as commodities rebounded.
Japan's Nikkei stock average <.N225> reversed earlier gains and slipped almost half a percent on Tuesday as the yen stayed near a record high versus the dollar. <.T>
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Shanghai copper rose on Tuesday, climbing for a third straight session.
Gold prices held steady and resilient physical demand from Asia also lent support, while Oil kept its gains after U.S. crude jumped more than 4 percent to its highest level in more than two months on Monday.
While some encouraging signs emerged to reflect improving sentiment and some willingness to take risks, caution and skepticism about a long-term solution to the euro zone crisis may keep recovery short-lived.
Asian markets are on a long-term rising trend based on fundamentals but the markets may turn their focus on worries over the U.S. and European economy, which will affect exports from Asia, Cheung said.
Even if (Europe's) measures are delivered, there is still concern that the EFSF is not enough to contain euro zone debt problems from spreading out.
HSBC's flash purchasing managers' index (PMI) on Monday showed China's vast manufacturing sector expanded moderately in October, reflecting the resilience of robust domestic demand and soothing fears of an abrupt slowdown in the world's second-largest economy.
China's PMI data and Caterpillar's results pushed the Standard & Poor's 500 Index <.SPX> up near a key technical level on Monday, with the index testing a 61.8 percent retracement of the 2011 decline.
On Monday, global stocks <.MIWD00000PUS> hit a seven-week high and commodities rallied on hopes Europe was moving closer to resolving the debt crisis.
The euro edged lower on Tuesday but still held near a six-week high Of $1.39570 hit the previous day, supported by market expectations for broad crisis-tackling measures from a summit due on Wednesday.
Funds want a bit more of a rise in markets to take profits before they close their books for the year, so that may help support the market in the near-term, Ii said. At the same time, there are also needs to cash out to cover losses.
Gains on Wall Street weighed on safe-haven U.S. Treasuries. Benchmark 10-year Treasury notes fell 4/32 in price for a yield of 2.23 percent on Monday.
But lingering worries about the extent of progress made over the euro zone sovereign debt problems pushed the spread between the yield on the 10-year Italian BTP benchmark bond and the equivalent German Bund wider on Monday to 388 basis points.
The spreads on the iTraxx Asia ex-Japan investment grade index, a gauge for whether investor risk appetite is returning, narrowed by a couple of basis points early on Tuesday.
Hong Kong-based Sun Hung Kai Properties, Asia's largest developer by market value, issued 5-year $500 million bonds on Monday at 245 basis points above U.S. Treasuries, in line with final guidance.
Data on Monday showed huge outflow of funds from emerging markets were reversing.
EPFR Global-tracked Bond Funds recorded net inflows of $2.51 billion in the week ending October 19. In mid-October, investors returned into high yield bond funds, with the combined U.S., Europe and Global high yield funds absorbing over $3 billion during the same week.
EPFR Global also reported on Monday that an increased risk appetite helped Emerging Market bond funds snap a short, sharp outflow streak.
(Additional reporting by Kityin Boey in Singapore; Editing by Kavita Chandran)