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London - Stocks rose and US government bonds saw their worst sell-off in 18 months on Wednesday as a deal on US taxes highlighted Washington's expansionary fiscal stance and its likely impact on growth and future deficits.
The prospect of higher US deficits forced bond yields near six-month highs and boosted the dollar's appeal.
European equities turned positive as investors shifted their attention from euro zone debt worries to focus on the prospects for further recovery, while Wall Street was set to open higher.
The US plan for a fiscal boost to an economy struggling with high unemployment contrasts sharply with policy in the euro zone, where a sovereign debt crisis has forced economies into ever harsher rounds of spending cuts.
"It's becoming increasingly clear the US is taking a very different approach to the Europeans in dealing with their debt overhang ... they're reflating their way out of it and the Europeans are going the opposite way," said Grant Turley, strategist at ANZ.
US Treasury prices have fallen by 2% in two days after President Barack Obama proposed extending tax cuts aimed at support economic growth, reinforcing the Federal Reserve's multi-billion dollar bond-buying programme, but unleashed fears about the longer-term rise in the national debt level.
The yield on 10-year Treasuries rose by 5 basis points to 3.19%, having risen to 3.255% in Asian trading, its highest since late June.
"At the moment, the market is taking the rise in US yields as a positive for the dollar rather than a supply story," said Adam Cole, global head of FX strategy at RBC Capital Markets. "There are rising expectations for growth, where growth is a scarce commodity."
While the economy may gain a much-needed boost from the tax cuts, the move will also likely swell the $1.3 trillion US budget deficit, which has already persisted for nearly two solid years, and this prospect prompted investors to shed Treasuries, thereby driving up the risk premiums on US debt.
"The tax cuts have changed the market's landscape," said Arihiro Nagata, fixed income manager at Sumitomo Mitsui Banking Corp.
"A lot of people are now changing their scenarios. Many economists are saying the tax cuts will push up US growth by 0.5 to 1.0% point."
The rise in US borrowing costs gave the dollar an edge over the euro among yield-hungry investors, thereby also delivering a blow to gold, which has shed 2.5% since hitting a record-high on Tuesday, as its investment appeal diminishes as rates rise.
The dollar strength pushed the euro towards important support levels around $1.3200 as the European bloc comes under pressure over high debt levels.
Spot gold was down 0.3% on the day at $1 396.25 an ounce, having risen to an all-time high of $1 430.95 an ounce on Tuesday.
The weaker yen gave Japanese stocks a boost on the prospects of improved earnings for exporters.
The benchmark Nikkei average rose more than 1% hit its highest level in almost seven months, before closing up 0.9%.
With US Treasuries under fire, German government bonds fell, pushing yields on two-year debt up with two-year yields by 4 basis points to 0.9%, while yields on the benchmark 10-year Bund rose 5 basis points to just shy of 3.0%.
Meanwhile, the stronger dollar weighed on commodities.
US crude oil futures fell for the second day in a row, losing nearly a dollar to trade at $88.01 a barrel, while benchmark industrial metal copper slid more than 1% to $8 785 per tonne after hitting a fresh peak of $9 044 on Tuesday.
