Global Markets - Selloff continues in stocks; investors fret over high bond yields

By Caroline Valetkevitch

NEW YORK (Reuters) - Stocks in world markets remained on shaky ground on Thursday, with major U.S. stock indexes sinking about 2 percent, as U.S. bond yields earlier crept back towards four-year highs.

Treasury yields, which were almost flat in U.S. afternoon trading, had climbed after the Bank of England said interest rates probably need to rise sooner, adding to expectations of reduced central bank monetary stimulus globally.

Bond prices have weakened in the past week-and-a-half as investors adjusted for the likelihood of a stronger U.S. economy and higher inflation, which could lead the Federal Reserve to boost interest rates more times than previously anticipated.

The move has kept equity investors nervous about higher rates and inflation.

"Now we are having acute attention on what happens in the bond markets, so when yields move up there is an unsettling feeling in the equity market. Things haven't quietened down," said Jason Ware, chief investment officer and chief economist at Albion Financial Group in Salt Lake City, Utah.

"As rates rise, things, as far as equity investors are concerned, are getting worse," he said.

The Dow Jones Industrial Average fell 511.44 points, or 2.05 percent, to 24,381.91, the S&P 500 lost 45.75 points, or 1.71 percent, to 2,635.91 and the Nasdaq Composite dropped 131.34 points, or 1.86 percent, to 6,920.65.

The pan-European FTSEurofirst 300 index lost 1.74 percent and MSCI's gauge of stocks across the globe shed 1.33 percent.

Emerging market stocks lost 0.95 percent.

The recent selloff, sparked by last Friday's jump in Treasury yields, sent the VIX index, Wall Street's "fear gauge," sharply higher. The index was back up above the 30 level on Thursday.

RISING BOND YIELDS

An improving outlook internationally is adding to pressure on global fixed income markets. The Bank of England raised its growth forecasts for Britain due to the strong global recovery.

"We've got yet another confirmation that a major central bank is wringing its hands over the possibility that economic growth is accelerating beyond current capacity," said Jim Vogel, an interest rate strategist at FTN Financial in Memphis, Tennessee.

Also underpinning yields, U.S. congressional leaders Wednesday reached a two-year budget deal to raise government spending by almost $300 billion.

While the deal was a rare display of bipartisanship that should stave off a government shutdown, it looks set to widen the U.S. federal deficit further and could fan inflation.

Benchmark 10-year notes last fell 2/32 in price to yield 2.8403 percent, from 2.832 percent late on Wednesday.

European bond yields also rose, lifted by the prospect of increased fiscal spending after Wednesday's coalition government deal in Germany.

Oil prices fell to their lowest in six weeks after data showed U.S. crude output had reached record highs and the North Sea's largest crude pipeline reopened following an outage.

U.S. crude fell 1.17 percent to $61.07 per barrel and Brent was at $64.72, down 1.21 percent on the day.

In the foreign exchange market, the dollar was flat after earlier hitting two-week highs against a basket of major currencies as investors reduced bearish bets on the greenback.

The dollar index was flat, with the euro down 0.03 percent to $1.2258.

(Additional reporting by Lewis Krauskopf, Megan Davies and Karen Brettell in New York, Hideyuki Sano in Tokyo and Sujata Rao in London; Editing by Bernadette Baum)