By Jamie McGeever
LONDON (Reuters) - A worldwide sell-off in government bonds deepened on Wednesday, with the rise in long-term borrowing costs to their highest level this year spreading unease across all assets and putting stock markets under pressure too.
European equities stabilised after the previous session's heavy losses as upbeat regional economic and corporate reports helped. But bond yields continued to push higher, with investors reassessing the early year deflation scare in the light of a 50 percent rebound in oil prices from January's trough.
That deflation scare, itself driven by a halving of energy prices at the back end of 2014, had unleashed a wave of central bank interest rate cuts and bond buying by the European Central Bank, sank many bond yields to zero and below and lifted relatively higher yielding equities to ever higher records.
With oil now bouncing back sharply and after last week's news that Europe ending four months of consumer price deflation last month, there has been some reversal of those trades.
Oil prices jumped another 2 percent on Wednesday to their highest this year.
Germany's 10-year yield hit a 2015 high just under 0.6 percent. The yield has more than tripled in a week and risen 10-fold in just three weeks, erasing all the gains made this year.
Benchmark 10-year yields on Spanish, Italian and UK government bonds also hit year highs before retreating back below Tuesday's closing levels. The 10-year U.S. Treasury yield was within three basis points of a 2015 peak too.
"The six million dollar question is (whether) this is a new trend or a positioning washout which will run its course in the next few hours?" said Deutsche Bank economist Robert Burgess.
"When you get big crowded positioning and everything becomes consensus, it doesn't take much to trigger an unwind."
Spain's benchmark yield hit 1.96 percent, Italy's 1.98 percent and Britain's gilt yield broke through 2 percent, although the selling abated throughout the morning.
Europe's index of leading 300 stocks was up 0.1 percent on the day at 1,557 points, having earlier touched a two-month low of 1,545. In choppy trading, Germany's DAX was up 0.7 percent, having also hit a two-month low earlier in the session.
The euro zone's blue chip benchmark EuroStoxx50 regained almost 1 percent of the 2.4 percent losses it recorded on Tuesday.
Corporate earnings results and surprisingly strong data showing Spain's services sector growing at its fastest pace since 2000 helped cushion European stocks.
U.S. futures pointed to a slightly higher open on Wall Street. The S&P 500 lost 1.18 percent on Tuesday, and the Nasdaq 1.55 percent.
REFLATION
Bonds have been among the best performing asset classes in recent years thanks to low inflation and the unconventional policy easing by the world's central banks. But signs are emerging that investors are tired of chasing ever-shrinking yields.
And some traders said there was concern that losses incurred on bond-heavy portfolios may see investors cash in on some of their best performing trades of the year to date.
One of the most crowded trades in equities is also showing signs of crumbling. In the six months to the end of April, Chinese stocks doubled in value. On Wednesday they fell 1.6 percent, following the previous day's 4-percent slump.
A major index of Asian shares is down 3 percent from a more than seven-year high on April 29. MSCI's broadest index of Asia-Pacific shares outside Japan fell 1 percent on Wednesday, and Australian stocks ended down 2.3 percent.
"If the rise in yield resulting from dumping Bunds is compounded into other G10 government bonds by possible signs of oil-driven reflation currents, then stocks will have to take notice," City Index chief markets strategist Ashraf Laidi said.
A broad bounce in commodities saw oil and copper prices rise to their highest levels so far this year.
Brent crude was up 2.2 percent on the day at $68.99 a barrel, with U.S. crude up 2.4 percent at $61.88.
In currencies, the dollar remained under pressure after data on Tuesday showed that the U.S. trade deficit widened sharply in April, suggesting the economy probably shrank in the first quarter.
The euro was the main winner, its allure brightened by the steep rise in euro zone bond yields. The common currency was up 0.5 percent at $1.1240.
The dollar index was down a third of one percent at 94.813, retreating from a one-week high of 95.946.
Later in the day, Federal Reserve Chair Janet Yellen is scheduled to speak and markets will be super sensitive to any guidance on the outlook for the first hike in interest rates.
European markets shrugged off news that Greece met 200 million euro interest payment to International Monetary Fund due on Wednesday.
Athens is quickly running out of money and is trying to persuade euro zone partners and the IMF to extend further aid. A bigger test will be a 750-million-euro payment due on May 12.
(Additional reporting by Saikat Chatterjee in Hong Kong; Editing by Toby Chopra; To read Reuters Global Investing Blog click on http://blogs.reuters.com/globalinvesting; for the MacroScope Blog click on http://blogs.reuters.com/macroscope; for Hedge Fund Blog Hub click on http://blogs.reuters.com/hedgehub)
