Risky assets rebound on China second thoughts

A woman looks at an electronic board with stocks information at a brokerage house in Hefei, Anhui province January 12, 2010.

NEW YORK (Reuters) - Risky assets, including stocks and higher-yielding currencies, rebounded on Wednesday on solid earnings expectations and a view that this week's surprise monetary tightening in China bodes well for recovery.

Gold edged higher as a decline in oil prices offset the positive effect of a weaker U.S. dollar, which earlier helped the precious metal recoup a 2 percent drop on Tuesday.

Commodity-linked currencies such as the Australian dollar regained ground as the price of copper, driven in large part by Chinese demand, bounced off two-week lows, supported by a weaker dollar.

China moved to tighten monetary policy on Tuesday with plans to increase banks' required reserves next week.

"Today we are seeing a retracement and the realization that the impact of China's bank moves won't be so detrimental to the global growth scenario," said Omer Esiner, senior market analyst at Travelex Global Business Payments in Washington.

A more optimistic outlook from the Federal Reserve, which said in its periodic Beige Book report that U.S. economic activity was improving to include wider swaths of the country also bolstered investor sentiment.

U.S. stocks rose as investors bought financial and technology shares ahead of earnings from bellwethers Intel Corp (INTC.O) and JPMorgan Chase & Co (JPM.N) later this week.

A brokerage upgrade of drugmaker Merck & Co (MRK.N) and an upbeat outlook from Kraft Foods Inc (KFT.N) lifted healthcare and consumer-oriented shares.

The Dow Jones industrial average .DJI was up 53.51 points, or 0.50 percent, at 10,680.77. The Standard & Poor's 500 Index .SPX was up 9.46 points, or 0.83 percent, at 1,145.68. The Nasdaq Composite Index .IXIC was up 25.59 points, or 1.12 percent, at 2,307.90.

Risky assets fell so far in price during the steep downturn that despite last year's strong rally they are not running ahead of fair valuation relative to the recovery process, said Jonathan Xiong, a global investment strategist at Mellon Capital Management in San Francisco.

However, there is a divergence to the recovery process in emerging markets, which have recovered, relative to developed markets, which for the most part have not, Xiong said.

"China raising reserve requirements is not necessarily a bad thing," he said. "The U.S. raising interest rates ahead of its own recovery in the economy could be a bad thing... but China has already recovered."

Oil prices fell below $80 a barrel, pressured by a U.S. inventory report showing increases in crude and distillate fuel stocks despite severe winter weather.

Crude stocks, expected to rise by 1.2 million barrels, shot up by 3.7 million, the Energy Information Administration said. Inventories of distillates, forecast to fall, rose by 1.4 million barrels.

"It's a bearish report that points back to weak underlying fundamentals in the domestic petroleum market," said Gene McGillian, analyst at Tradition Energy in Stamford, Connecticut.

U.S. Treasury prices fell as a renewed appetite for stocks and other risky assets curbed demand for government bonds while an auction of 10-year notes enticed some investors.

Lingering jitters over appetite for Thursday's $13 billion of 30-year bonds, the last of this week's $84 billion Treasury supply, also curbed bond demand, analysts said.

The dollar was down against a basket of major currencies, with the U.S. Dollar Index .DXY down 0.16 percent at 76.831.

The euro was up 0.12 percent at $1.4512, and against the yen, the dollar was up 0.47 percent at 91.38 yen.

U.S. crude for February delivery fell $1.14 cents to settle at $79.65 a barrel. It earlier fell to $78.37, the lowest since December 29.

In London, Brent crude for February delivery, which expires on Thursday, fell 99 cents to settle at $78.31.

Gold for February delivery settles up $7.40 at $1,136.80 an ounce in New York.

The benchmark 10-year U.S. Treasury note was down 19/32 in price to yield 3.79 percent.

In Asian markets the Thomson Reuters index of regional shares .TRXFLDAXPU was down almost 1 percent, while Japan's Nikkei .N225 closed down 1.3 percent.

(Reporting by Rodrigo Campos, Edward McAllister, Nick Olivari, Vivianne Rodrigues, Richard Leong and Chris Kelly in New York; writing by Herbert Lash, Editing by Chizu Nomiyama)