World stocks hit a fresh four-month high on Tuesday while government bonds steadied after signs of improvement in the U.S. housing sector and increasing optimism about banks triggered a rally on Wall Street.

The benchmark MSCI world equity index <.MIWD00000PUS> is now in positive territory for the year. The latest rally stemmed in part from Monday's U.S. data showing pending sales of existing homes rose unexpectedly in March, which boosted expectations that the worst might be over for the world's biggest economy.

Investors are anxiously waiting for the result of a stress test on 19 U.S. banks due this week. A source told Reuters that about 10 banks would be told they needed to increase the size of their capital cushions.

Another source told Reuters that an expected first-quarter loss for insurer American International Group would not trigger a new capital injection from the government. The MSCI world equity index rose a quarter percent, hitting its highest level since early January. The index is now up 2.6 percent this year, after falling 43 percent last year.

The FTSEurofirst 300 index <.FTEU3> rose half a percent with the banking sector one of the biggest risers, while emerging stocks <.MSCIEF> rose a third percent.

The general tone is positive so the bulls will have it today but the bears are still lurking around the corner ... Everything is going to be dominated by what happens to the bank stress test on Thursday, said Justin Urquhart Stewart, director at Seven Investment Management.

A lot of the stress test is designed for public consumption to try and give people confidence that the banks are going to be viable. The question is which of them is going to need capital to be able to survive.

COMPANY RESULTS

A clutch of major U.S. companies report their Q1 results this week. Thomson Reuters data shows that so far, 66 percent of 326 companies in the S&P 500 index have reported earnings above analyst expectations.

In aggregate, U.S. companies are reporting earnings that are 10.4 percent above the estimates, which is above the long-term average of around 1.6 percent.

Also helping sentiment, the White House said on Monday it did not see a need to ask the U.S. Congress for more money to support banks.

Reports have pointed to Bank of America and Citigroup among those who will be instructed by regulators to raise more capital.

The Australian dollar held near a seven-month high around US$0.7426 after the country's central bank left its key cash rate at 3 percent as expected, pointing to signs of stabilization abroad.

The dollar rose half a percent <.DXY> against a basket of major currencies while the yen was steady at 98.99 per dollar.

U.S. crude oil fell 1.2 percent to $53.78 a barrel -- which is still close to a 2009 high.

The June Bund future was little changed with focus on a monetary policy verdict from the European Central Bank on Thursday.

(Additional reporting by Joanne Frearson, editing by Mike Peacock)

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