US bond yields surge, stocks erase gains

US government bond prices fell sharply on Tuesday amid worries over the fiscal outlook, while Wall Street stocks ended up only slightly as bond yields rose and an insider trading scandal worsened.

The euro was mostly weaker as Ireland's Parliament debated a tough austerity budget, reminding investors of the euro zone's indebtedness, while the US dollar benefited from rising treasury yields.

Investors bailed out of US treasuries after President Obama proposed a deal on tax cuts and unemployment payments that would boost economic growth in the short term but raise debt levels longer term.

Moody's Investors Service said US finances could suffer in the long run, though it did not foresee a change to the country's AAA credit rating in the next 18 months to two years.

"This reduces revenue on top of extending jobless benefits, which is bad for deficits. In the short run this is good news, but two to three years down the road foreign buyers of US treasuries may start to balk," said David Carter, chief investment officer at Lenox Advisors in New York.

Rising US bond yields spooked the stock market with investors worried that higher borrowing costs could hurt corporate profits and consumer spending.

"The spike in interest rates could be enough to stop the equity rally in its tracks," said Peter Boockvar, equity strategist at Miller Tabak & Co in New York.

Stocks in Europe and America initially gained in reaction to President Obama's proposed tax plan which is seen boosting US economic growth and lowering unemployment. Concern about rising US bond yields and a widening probe by regulators into insider trading saw stocks lose early gains and end little changed in New York though.

News late in the trading day that federal authorities have ramped up an investigation into insider trading on Wall Street fueled selling in the equities market.

The Dow Jones industrial average ended down 3.64 points, or 0.03%, at 11,358.55, with the Standard & Poor's 500 Index up just 0.68 points, or 0.06%, at 1,223.80. The Nasdaq Composite Index was up 3.57 points, or 0.14%, at 2,598.49.

The benchmark 10-year US treasury note saw its biggest one-day sell off since June, with the yield rising to 3.14%. The two-year US treasury note was down 732, with the yield at 0.5318%. The 30-year US treasury bond was down 7032, with the yield at 4.3703%.

The Obama tax plan would cost $501 billion in lost tax revenues, according to the non-partisan Congressional Budget Office, at a time when investors are increasingly concerned about US budget deficits that have approached 10% of economic output in recent years.

The bond sell-off intensified after a disappointing three-year debt auction and fears over its impact on bidding at subsequent sales of 10-year and 30-year debt later this week, they said.

The US dollar rose the most against the yen in nearly three months on Tuesday after the proposed extension of US tax cuts triggered higher Treasury yields, though the longer-term impact on the greenback is less clear given an already large US deficit.

The euro fell versus the US dollar and analysts expect the euro zone single currency to remain under pressure and slide below $1.30 in coming weeks as fears about the euro zone's debt problems persist.