NEW YORK (Reuters) - U.S. stocks fell on Tuesday as investors cashed in gains after driving the S&P 500 index to its highest in four years, but the euro rallied against the dollar on hopes the European Central Bank will soon start buying Spanish and Italian bonds to contain the debt crisis.
Spanish borrowing costs fell and Portuguese government bond yields slid to levels reached before Lisbon agreed to a bailout deal in May 2011, with traders citing media reports that the ECB was drawing up detailed plans about bond-buying.
The perception of declining risks from the euro crisis has been a major factor behind stocks' recent gains. Earlier in the session, the broad Standard & Poor's 500 Index .SPX climbed to its strongest intraday level since May 2008, before surrendering gains ahead of technical resistance.
"It's not uncommon that you run into some resistance at new highs," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. "Traders sort of play for a while to see which way the market is ultimately going to resolve itself."
Uncertainty remained high and investors were concerned that the ECB's requirement that troubled countries ask for help from the euro zone's rescue funds before turning to the central bank may mean that the Spanish crisis could get worse before it gets better. Still, optimism over eventual ECB action bolstered sentiment.
"The market has moved to the belief that (the ECB) is going to do whatever it takes," said William Larkin, fixed-income portfolio manager at Cabot Money Management in Salem, Massachusetts.
The Daily Telegraph, a British newspaper, supported a report over the weekend in a German magazine that the ECB planned to put a hard cap on Spanish and Italian bond yields.
An ECB spokeswoman, asked about the Telegraph story, referred to the ECB's statement on Monday, when it said it was misleading to report on policy decisions that had not been made.
U.S. stocks closed lower. The Dow Jones industrial average .DJI ended down 68.06 points, or 0.51 percent, at 13,203.58. The S&P 500 Index .SPX closed down 4.96 points, or 0.35 percent, at 1,413.17. The Nasdaq Composite Index .IXIC fell 8.95 points, or 0.29 percent, to 3,067.26.
The S&P 500 has risen 2.4 percent so far in August. Volume has been light as investors wait for central banks' meetings next month, where policymakers are expected to take action to ease Europe's debt crisis and boost the economy.
The MSCI global share index .MIWD00000PUS gained 0.3 percent to 326.34 after hitting an intraday high at 328.21, its highest level since early May. The FTSEurofirst 300 index of European shares .FTEU3 gained 0.4 percent to end at 1,109.55.
Yields at a Spanish short-term debt auction fell on Tuesday, while Europe's VSTOXX volatility index .V2TX hit a one-month low, signaling a steady rise in investors' appetite for risk.
Spanish 10-year bond yields fell 10 basis points to 6.24 percent, with shorter-dated yields down as much 16 basis points. Italian bond yields also dropped.
Portuguese 10-year yields fell 30 basis points on the day to 9.40 percent, the lowest level since April 20. Portugal's original request for a bailout was on April 6, 2011; the deal was announced on May 3 of last year.
Financial markets have been on a red-hot run on hopes that the new urgency in Europe to overcome the 2-1/2-year debt crisis may let Greece remain in the euro zone and keep the 17-member bloc from unraveling.
Greek Prime Minister Antonis Samaras will meet German Chancellor Angela Merkel, French President Francois Hollande and Eurogroup chief Jean-Claude Juncker in the coming days to try to secure more help from the European Union, International Monetary Fund and ECB, even though Greece has fallen behind on its debt-cut targets.
Samaras is expected to lobby for a two-year extension of austerity measures to soften their impact, though he is unlikely to win major concessions.
The euro climbed 1 percent to $1.2462, while the dollar slipped 0.2 percent to 79.24 yen.
U.S. Treasury debt prices erased losses as the major U.S. stock indexes gave up early gains. The benchmark 10-year U.S. Treasury note was up 2/32 in price to yield 1.8036 percent.
Brent crude oil rose 94 cents to settle at $114.64 a barrel. It has jumped from below $90 at the end of June, propelled higher by maintenance in the North Sea and increased fear of military conflict between Iran and Israel.
U.S. crude added 71 cents to settle at $96.68 per barrel.
Gold rallied to a 3-1/2 month high as the U.S. dollar weakened, while platinum hovered just below a two-month peak hit in the previous session as concerns over supply from top producer South Africa festered.
Spot gold hit a high of $1,641.20 an ounce. It was last at $1,637.70 an ounce.
Additional reporting by Edward Krudy and Nick Olivari, Chris Reese and Rodrigo Campos; Editing by Dan Grebler