GLOBAL MARKETS-Stocks rally cut off by EU threats over Italy's budget

* Graphic: World FX rates in 2019 http://tmsnrt.rs/2egbfVh

By Virginia Furness
LONDON, May 28 (Reuters) - European stocks, bond yields and
the euro fell on Tuesday as concern about Italy's budget
overshadowed talks of a Fiat-Chrysler and Renault merger and the
muted showing of nationalists in European Union parliamentary
elections.
After gains in Asia, hopes that European stocks would open
higher were dashed, with Italian shares falling more than half a
percent, unwinding early gains in both the pan-regional STOXX
600 .STOXX and Germany's DAX .GDAXI .
Markets had been cheered by limited gains for nationalists
in the EU elections, though wins for eurosceptic parties in
Italy, France, Poland and would-be ex-member Britain, as well as
snap elections in Greece and political turmoil in Austria,
curbed risk appetite. However, Italy's dispute with the European Commission
emerged to dominate European trading as markets opened. The
Commission could fine Italy 3 billion euros for accumulating
debt and deficits that break EU rules, Italian Deputy Prime
Minister Matteo Salvini said on Tuesday. "It reopens the whole agenda of whether Salvini wants to be
part of the euro or not," said Colin Harte, a portfolio manager
and strategist at BNP Paribas Asset Management.
"The danger is that the [dispute between Salvini and the EU]
turns out to be more aggressive on both sides, then you will see
people switch out of positions]," Harte said.
The spread of Italian 10-year debt over top-rated Germany
reached around 100 basis points between mid-October and
mid-March, but since then has blown out to 285 basis points
DE10IT10=RR .
German government bond yields, deemed the region's safest
asset, fell four basis points to a two-and-a-half-year low. The
euro weakened 0.11% against the dollar EUR=EBS .
U.S. yields were also lower. Benchmark 10-year Treasury
notes US10YT=RR yielded 2.27%, down five basis points.

TRADE TALKS KEEPS THINGS TIGHT
Trade worries remained high. U.S. President Donald Trump said on
Monday that Washington was not ready to make a deal with China,
but he expected one in the future. At the same time, he pressed
Japanese Prime Minister Shinzo Abe to reduce Japan's trade
imbalance with the United States. Hope for a U.S. - China trade agreement still underpins
optimism in global markets, but U.S. 500 e-mini futures were
down almost 0.25 percent ESc1 .
"Markets are holding their nerve and will start to attach
great hope to the meeting between Presidents Xi and Trump in
June," said BNP Paribas's Harte. "But I'm not as convinced that
Trump wants a deal."
"The big risk is that the U.S. starts being disruptive to
supply chains ... and the big problem is we don't really
understand how much damage this will do."
Asian shares rose, lifted by advances in China and gains by
auto firms after Fiat Chrysler FCHA.MI made a "transformative
merger" proposal to French peer Renault.
Auto stocks rose globally rose after Fiat Chrysler FCHA.MI
confirmed it had made proposed a merger with Renault RENA.PA ,
a deal that would create the world's third-biggest carmaker. The
rally spilled into Asia with Mitsubishi Motors Corp 7211.T in
Japan adding 5.95% and Nissan Motor Co 7201.T gaining 2.31%.
A planned increase in the weighting of Chinese A-shares in
MSCI indexes after the market closes on Tuesday also boosted
shares.
The dollar index .DXY, which tracks the U.S. currency
against a basket of six other major currencies, rose 0.15%
higher at 97.747.
In commodity markets, oil prices extended gains after rising
more than 1% on Monday. Prices rose on tensions in the Middle
East and continuing Russian supply disruptions after a
contamination problem discovered last month. Brent crude LCOc1 was 0.29% higher at $70.31 per barrel,
having earlier dipped below the $70 mark. U.S. West Texas
Intermediate crude CLc1 gained 1.16% to $59.31 per barrel.