Shares rose on Wednesday as hopes grew of a U.S. interest rate cut to calm turbulent markets but an increase in risk appetite sent bonds lower and put the yen under pressure.
Worries over the U.S. mortgage crisis that has roiled global markets still overshadowed sentiment and analysts doubted that credit problems were over yet.
U.S. stocks looked set for a firm opening given rises in stock futures as investors ventured out of the safe haven of bond markets and counted on the U.S. Federal Reserve to ensure there was no fully fledged credit crunch.
The FTSEurofirst 300 index of top European shares was up 1.3 percent at 1,501.98 points, on track for its fourth successive day of gains after a rout that brought European shares down some 9 percent since a 6-1/2 year peak in mid-July.
The correlation between equity and credit markets is unjustified as prospects for the global economy and corporate profitability are not under threat, said Alain Bokobza, head of strategy at Societe Generale in Paris.
Equities have the capability to rebound, and my case is for them to regain ground by year-end but in a more volatile environment than we've had for a few years.
Bond markets were less sanguine as dealers said the Fed's actions to date were not bold enough to draw a line under the credit market problems. But there was some comfort in signals from the U.S. monetary authorities that they may be willing to ease policy if needed.
Speculation that the U.S. Federal Reserve might cut its benchmark interest rate soon was sparked by comments from Sen. Christopher Dodd, chairman of the Senate Banking Committee, who said Fed Chairman Ben Bernanke had told him the central bank was ready to use all available tools to calm financial markets.
Two-year paper saw profit-taking call a halt to its massive two-week rally on a flight to liquidity. The two-year note fell 5/32 to yield 4.13 percent, up from a two-year low of 3.96 percent hit earlier in the week.
We saw some profit-taking overnight, unwinding of safe-haven trades, said Kim Rupert, managing director of global fixed-income analysis at Action Economics.
But the ongoing fear of the unknown still permeates the market, so we're still seeing yields at pretty low levels.
European two-year Schatz paper also fell back as investors sold. The two-year Schatz yield was up 7.9 basis points at 3.95 percent. The 10-year Bund yield was up 2.7 basis points at 4.26 percent.
INVESTORS VENTURE OUT OF SAFE HAVENS
The desire for higher returns sparked renewed selling of the low-yielding yen in carry trades in favor of the higher- yielding dollar, euro, and Australian and New Zealand dollars, while European equity markets were higher and top-rated government bond prices fell.
Widespread expectations that the Bank of Japan will keep interest rates on hold at an ultra-low 0.5 percent on Thursday, in the current climate of nervous financial markets, also weighed on the yen, analysts said.
I guess the markets are saying not only will the BOJ postpone the August hike but increasingly it will (hold off) in September too, said Michael Klawitter, currency strategist at Dresdner Kleinwort in Frankfurt.
That leaves the negative carry for the yen too large, following the recent correction, and too tempting for speculators to get back in. But (cross yen) rallies will be temporary and nobody will be willing to bet on any lasting upward move.
The dollar was up 0.7 percent on the day at 115.15 yen, continuing to consolidate after hitting a 14-month low of 111.60 yen last week.
The euro rose 1 percent against the yen to 155.50 yen and was up 0.3 percent against the dollar at $1.3500.
The Australian dollar was up 1.5 percent against the yen at 92.85 yen and the New Zealand dollar was up 1.5 percent at 80.64 yen.
MSCI's measure of Asia Pacific stocks excluding Japan rose 1.6 percent, following a 6 percent jump on Monday -- its biggest one-day percentage gain since September 1998.
The MSCI index is now almost 10 percent above a five-month trough plumbed last Friday, but still nearly 13 percent below its July 24 record high.
But Japanese shares closed a touch weaker as investors awaited the outcome of the Bank of Japan's policy meeting, with financial stocks such as Resona Holdings lower after recent gains. The broader TOPIX index lost 0.3 percent, while the benchmark Nikkei average was flat, losing less than 1 point to end at 15,900.64.