Rising US bond yields have finally got the attention of stockmarket investors, triggering a reversal of Tuesday’s mindless surge in optimism and share prices.

Wall Street saw a big 2% plus fall across the board overnight after yields on US 10-year bonds jumped a nasty 0.23% in a day’s trading: from 3.51% to a closing 3.74%. That was the highest level for six months.

Ten year yields have jumped from 2.9% around a month ago as investors have increasingly fretting about the $US2 trillion of bond issues to fund the escalating US budget deficit.

Bloomberg said the difference between 2-year bond yields and those on 10-year bonds is now the steepest every recorded in the US with the yield difference 2.75%, a sign of real stress in the market, or a belief that that the US is about to have the biggest surge out of a recession it has seen.

That’s not forecast, so the strains are coming from rising worries about the huge funding plans for the rising US deficit which will be around $US1.8 trillion.

The surge in long dated bond yields has started hitting mortgage lending, crimping the Fed’s moves to free up home lending. Since the Fed started its quantitative easing policy, yields on 10 year bonds are up 1.2% on the lows they fell to after the announcement on March 18.

Long term bond yields in Germany, the UK and Australia have been rising as well: 10 year bond yields here traded close to 5.495% this morning, the highest since early last October.

Oil prices closed well above $US63 a barrel ahead of the OPEC meeting decision tonight that will keep production quotas steady, according to analysts.

Helping drive bond yields higher was dissatisfaction with the reception given to a huge $US35 billion auction of five year bonds: while well supported, the so-called covered ratio (which describes the level of interest) was lower for the five year bonds sold overnight than for the shorter term two year notes that went the day before.

That got some investors wondering if investors preferred to keep their holdings at the short end of the yield curve rather than go long.

We will know tonight when a huge $US26 billion auction of seven year bonds is scheduled.

Not even a report from ratings agency Moody’s that it was comfortable with America’s fiscal position, budget and debt situations, was enough to calm nerves among fretting bond market investors.

Short term yields remain low because the Federal Reserve is buying short dated bonds as part of its “quantitative easing” policy designed to force lending to grow again. But mortgage bond yield have spiked as the longer dated bond yields have risen, causing a fall off in mortgage applications as home loans cost more.

US analysts now expect longer dated yields to rise as the market prices in evidence of “green shoots” in the economy, the huge US debt burden, inflation and the $2 trillion of new bond issues this year (Inflation thought isn’t a risk, that’s red herring).

Rising unemployment and falling tax revenues in all levels of government are further adding to the concern about debt levels and deficits.

The auctioning of $US101 billion of new Treasury debt this week far exceeds the Fed’s buying of $US7.55 billion to keep yields lower. The Fed plans to buy $US300 billion in Treasuries, the Treasury will issue $2 trillion (and has sold $US800 billion so far this year).

It’s an unequal task.

Complicating matters for the bond market is the looming losses from the almost certain bankruptcy for General Motors.

GM confirmed that bond holders nixed an offer from the company to trade $US27 billion of debt for equity stakes, making it much more likely that GM will declare bankruptcy. That $US27 billion will be lost and will rattle the credit default swap market again and add to pressures on AIG, Citigroup and other weakened financiers.

In banking the US Federal Deposit Insurance Corporation says its list of problem banks now numbered 305 at the end of March, up from 252 at the end of December.

Some of those banks on the list at the end of March have gone bust (more than a dozen). The 305 on the list was the highest since 1994.

So dramatic was the change of sentiment as trading worse on overnight that not even a 2.9% rise in sales of existing homes across the US in April could stop the slide in the market. If anything it may have helped push bond yields higher.

Tonight analysts are expected better news on sales of new homes in April, but the real action in housing remains falling prices. But that’s not even registering in market thinking, at the moment.