The euro steadied on Thursday as dealers squared up positions ahead of a meeting of European Union leaders, while U.S. Treasuries bounced after a selloff overnight took 10-year yields above 3.5 percent, sending some investors hunting for value.

Traders were wary that a discussion in Brussels about a permanent mechanism to prevent fiscal crises from spreading may push up the euro toward $1.33, though persistently higher U.S. bond yields have been keeping the dollar broadly supported in thin, year-end markets.

The euro wobbled overnight after Moody's said it was considering downgrading Spain's credit rating and as a bond auction in Portugal saw its three-month borrowing costs nearly double. Spain will auction 10- and 15-year bonds later on Thursday.

Shrinking trading volumes in Asian equity markets have been a tell-tale sign that investors comfortable with their cash allocations are heading to the sidelines for the rest of the year rather than expose their portfolios to more risks.

A steep tumble in U.S. Treasuries in the wake of a deal in Washington to extend tax cuts, though, has kept fixed income fund managers nimble. Some investors see an end on the horizon to the selling pressure even though trend-following funds have kept upward pressure on yields in recent days.

Before the tax cuts, many investors had expected a 2.5-3.0 percent range for 10-year yields. Now their expectations have shifted to 3.0-3.5 percent. I think the 10-year yield will eventually fall, said Hiroshi Yokotani, fixed income director at Alliance Bernstein in Tokyo.

In equities, Japanese stocks continued to outperform global stock markets thanks to foreign investment.

Japan's Nikkei share average was flat, though up 1 percent <.N225> so far in the week, outperforming the MSCI all-country world index advance of 0.1 percent <.MIWD00000PUS>.

The Nikkei is taking a breather after a six-week rally, but sentiment remains bullish overall, said Takashi Ohba, a senior strategist at Okasan Securities in Tokyo.

Foreign investors have been net buyers of Japanese stocks for six consecutive weeks to December 11, purchasing a cumulative $9.8 billion worth of equities, Japan's finance ministry data showed.

The MSCI Asia Pacific ex-Japan index of equities fell 0.5 percent <.MIAPJ0000PUS> in sluggish trade, despite another flurry of positive U.S. economic data overnight. The consumer discretionary sector, which has been a popular buy this year, was down 1.6 percent, the biggest underperformer in the index, suggesting profit taking was at play.

After sliding more than 2 percent in November on early profit taking, the index has staged a rally in light turnover in December. It is up 3.6 percent so far in December.

Southeast Asian equities were the region's biggest underperformers in terms of countries on Thursday, though they will probably keep the crown of best performing Asian stock markets excluding frontier countries.

After accounting for currency moves, the benchmark stock index in Thailand is up 55 percent <.SETI> so far this year, followed closely by Indonesia and the Philippines, which have risen 47.5 percent <.JKSE> and 38.6 percent <.PSEi>, respectively.

Thailand and Indonesia were the third- and fifth-most favored countries to invest in among global emerging market investors, a Bank of America-Merrill Lynch survey released on Tuesday showed.

Fast-growing emerging economies are expected to remain strong draws for foreign investors in 2011.

EURO STEADIES, BUT FOR HOW LONG?

The euro was largely unchanged on the day at $1.3212, with talk of sell orders around $1.3300 keeping it hemmed in a tight range, traders said.

Chart support at $1.3164, the low of the range carved out in the past week, if breached could lead to a further decline to around $1.2969, the November low.

Ten-year U.S. Treasury futures expiring in March were up 8/32 after plumbing a 7-month low overnight. In the cash market, the yield on the 10-year note slid to 3.49 percent after climbing as high as 3.57 percent overnight.

The 10-year yield has risen nearly 90 basis points since November, contributing to a dramatic steepening of the yield curve of 2-year to 10-year debt to 282 basis points from 226 basis points at the beginning of November.

That spread is on course for the most widening in a quarter since the first quarter of 2008.

(Additional reporting by Antoni Slodkowski and Hideyuki Sano in Tokyo)

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