* U.S. yields turn higher in late trading as early buying fizzles * U.S. 10-year yield tests 3.10 pct, 3.21-3.23 pct seen next * Domestic factory output rises in April, housing starts fall (Recasts lead, updates late market action) By Richard Leong NEW YORK, May 16 (Reuters) - U.S. Treasury yields rose on Wednesday as the 10-year yield reached seven-year highs and tested key technical support at 3.10 percent, which may touch off another wave of bond sales if it rises much further above that level.
Wednesday's yield increase followed Tuesday's bond market selloff spurred by signs the U.S. economy is on a stronger footing in the second quarter.
"It's pure bearish momentum until it exhausts itself," said Karl Haeling, vice president at Landesbank Baden-Wurttemberg in New York. "Buyers don't want to come in until there is a better sign of stability." Disappointing economic growth data in Japan as well as concerns about the financial demands of a potential Italian coalition government from its neighbors caused a drop in German bond yields earlier Wednesday, briefly stemming another jump in U.S. yields.
The 10-year yield's sharp rise on Tuesday to above 3.05 percent, which was seen as a key technical support level, unnerved Wall Street as traders considered whether U.S. bonds were gaining appeal as an alternative to riskier stocks.
The higher U.S. yields, however, failed to sustain buying interest in bonds amid lingering concerns about another surge in Treasury debt supply and tensions between the United States and its trading partners, analysts said.
Data on Wednesday supported traders' view that the U.S. economy is expanding but far from firing on all cylinders. They did not change the notion that the Federal Reserve would stay on its gradual interest rate hike path.
U.S. industrial output grew 0.7 percent in April, while home construction declined 3.7 percent last month, government data showed.
The 10-year Treasury yield was up 1.5 basis points at 3.096 percent after touching 3.104 percent, which was the highest level since July 2011, in late Wednesday trading, Reuters data showed.
The 10-year yield, if it climbs meaningfully above 3.100 percent, will easily march towards 3.21-3.23 percent, with 3.50 percent as the next major chart support, according to analysts.
The two-year yield, which is sensitive to traders' views on Fed monetary policy, was marginally higher at 2.589 percent, which was the highest level since August 2008.
The modest yield rise on Wednesday did not shake the view of some investors that the bond market selloff is nearly done.
"Until that is a follow-through on wage growth, these yield levels are going to hold," said James Camp, managing director of fixed income at Eagle Asset Management in St. Petersburg, Florida.
The 10-year yield reversed an initial decline as Wall Street stock prices recovered some of Tuesday's losses. It also fell earlier in step with a fall in German Bund yields.
Italy's 10-year bond yield jumped nearly 19 basis points to 2.13 percent, its highest level since early March. Italian yields jumped in the wake of a draft program for a potential coalition government that revealed plans to demand 250 billion euros of debt forgiveness and create procedures to allow countries to exit the euro. May 16 Wednesday 4:36PM EDT/ 2036 GMT Price US T BONDS JUN8 140-27/32 -0-7/32 10YR TNotes JUN8 118-120/256 -0-36/256 Price Current Net Yield % Change (bps) Three-month bills 1.8725 1.9075 -0.007 Six-month bills 2.035 2.0847 0.000 Two-year note 99-150/256 2.5934 0.008 Three-year note 99-152/256 2.7672 0.011 Five-year note 99-28/256 2.9443 0.019 Seven-year note 98-204/256 3.0683 0.021 10-year note 98-16/256 3.1019 0.022 30-year bond 98-40/256 3.2213 0.012 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 22.75 1.25 spread U.S. 3-year dollar swap 17.25 1.50 spread U.S. 5-year dollar swap 9.25 1.25 spread U.S. 10-year dollar swap 3.25 0.50 spread U.S. 30-year dollar swap -7.50 0.50 spread (Reporting by Richard Leong Editing by Paul Simao and Diane Craft)