Euro, U.S. stocks unravel

A pedestrian is reflected in a stock index board outside a brokerage house in Tokyo May 28, 2010.

NEW YORK (Reuters) - The euro dropped on Thursday, dragging U.S. stocks lower, as skittish investors pulled back from early rallies despite economic data that supported expectations for a strong U.S. key jobs report.

U.S. Treasuries debt prices rose as stocks slid and investors sought safe havens.

The selling pressure was also weighed after a Hungarian official representing the new government gave a forecast for a budget deficit that greatly exceeded the current deficit target. Government officials said Hungary had a slim chance to avoid a Greek-style debt crisis.

The euro fell below important technical levels against the dollar, triggering declines in U.S. equity markets.

U.S. stocks were also dented as tepid May sales from retailers curbed investor optimism ahead of what is expected to be a solid government payrolls report on Friday.

Wall Street erased earlier highs as the S&P 500 nearly pierced its key 200-day moving average and the euro weakened against the dollar.

The S&P 500 and the euro have tracked each other very closely over the last 30 days. The two have tended to move in lock-step since they are barometers of investor appetite for risk. Traders use the euro as a proxy for concerns about the European debt crisis.

"The market seems to like it when the euro is stabilizing, and that seems to be a key point," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.

"There is still a high degree of caution in the markets right now. Many people don't want to step up in front of the jobs report," Ghriskey added.

On Friday, the critical May non-farm payrolls report is due, with economists looking for 513,000 non-farm jobs being added to the economy.

The price on U.S. 10-year government debt pared earlier losses on Thursday, as Wall Street moved into negative territory and revived safe-haven demand for bonds.

Benchmark 10-year Treasury notes were up 1/32 in price while their yield, which moves inversely to price, was last at 3.34 percent after hitting a two-week high of near 3.43 percent.

European markets, which closed ahead of the sell-off in the euro, rose to a two-week closing high. Oil companies bounced, helped by a surge in the price of crude and as growth in the euro zone services sector boosted sentiment.

"It's a relief rally, a snapback, after these horrifying days and weeks, with the Greek and European tragedy," said Franz Wenzel, strategist at AXA Investment Managers in Paris. "But we don't see any improvement, economically or valuation-wise. We expect shares to trade in a range."

The pan-European FTSEurofirst 300 .FTEU3 index of top shares rose 1.39 percent to end the day provisionally at 1,017.50 points, the highest close since May 18. The index is still down more than 8 percent from a mid-April peak, on worries a debt crisis in the eurozone could derail economic recovery.

The Dow Jones industrial average .DJI dropped 50.18 points, or 0.49 percent, to 10,199.36. The Standard & Poor's 500 Index .SPX shed 3.63 points, or 0.33 percent, to 1,094.75. The Nasdaq Composite Index .IXIC gained 0.46 points, or 0.02 percent, to 2,281.53.

The S&P retail index .RLX slipped 0.5 percent as retailers posted lackluster May same-store sales -- up 2.5 percent, on average, versus expectations of 2.6 percent growth.

Other data showed the U.S. non-manufacturing sector grew less than expected in May, even as it added workers for the first time since December 2007.

Global stocks as measured by MSCI .MIWD00000PUS climbed 1.0 percent, having earlier reached highs last seen on May 19.

Earlier, Tokyo's Nikkei share average .N225 rose over 3.0 percent, posting its biggest one-day rise in six months. Emerging markets stocks .MSCIEF rallied 1.7 percent, according to an MSCI index.

YEN PRESSURED

The Japanese currency, already on a shaky footing with political uncertainty in Japan weighing, fell across the board. The dollar rose 0.22 percent versus the yen to 92.38.

"Financial market conditions have stabilized in the near term. There's renewed risk-taking and that leads to a weaker yen," said Lee Hardman, currency analyst at BTM-UFJ.

Also, with the market speculating that Japan's next prime minister would take a tougher stance in fighting the yen's strength, traders took this as an opportunity to trim long positions in the currency.

Finance minister and candidate for ruling party head -- and the premiership -- Naoto Kan surprised markets earlier this year by saying he wanted the yen to weaken more and that most businesses were in favor of a dollar/yen rate around 95 yen.

Against a basket of major currencies, the dollar .DXY was up 0.29 percent. The euro was down 0.44 percent at

$1.2195.

Gold fell 0.58 percent, to $1,215.80, but U.S. crude oil futures rose 0.07 percent, to $72.91 per barrel.

(Additional reporting by Richard Leong; Editing by Leslie Adler)