* Dollar at 16-mth low on yen, gold highest since May
* European shares fall sharply, bonds surge in safety rush
* Hong Kong shares lead Asia equity markets lower
* Fed's Yellen upbeat on economy, acknowledged global risks
* US yield curve flattest since late 2007
By Marc Jones
LONDON, Feb 11 (Reuters) - Turbulence tore through global markets on Thursday as investors sought the safety of Japanese yen, gold and top-rated bonds while dumping U.S. dollars on bets the Federal Reserve could be done with raising interest rates.
Even the absence of Tokyo for a holiday could not stop the dollar from hitting a 15-month low on the yen, and gold finally broke major chart resistance to reach its highest since May as a wave of risk aversion swept through trading floors.
Europe got off to a torrid start, with Britain's FTSE 100 .FTSE down 2.3 percent, Germany's DAX .GDAXI 2.4 percent lower, France's CAC 40 .FCHI down 2.8 percent and U.S. futures also pointing to 1 percent drop for Wall Street ESc1 later.
Sweden's crown SEK= and government bond yields SE2YT=TWEB were sent tumbling as its central bank delivered a surprise cut to its already deeply negative interest rates. [nL8N15Q243 ]
Insatiable demand for U.S. Treasuries drove longer-term yields to almost three-year lows and flattened the yield curve in a way that has presaged economic recession in the past.
Benchmark European German Bund yields DE10YT=TWEB dropped like a stone and UK yields UK10YT=TWEB hit an all-time low too, as riskier Spanish ES10YT=TWEB , Italian IT10YT=TWEB and Portuguese PT10YT=TWEB bonds moved in the opposite direction.
The euro zone's finance ministers are set to meet later with worries creeping back in about Portugal and Greece's ability to stick to the terms of their bailouts again.
"What this shows is that the risk-off mode has come back very quickly and that the worst may still be to come in these markets," said Rabobank European strategist Emile Cardon.
"What is different to previous times is that the bad news in now coming from everywhere, China, Portugal the U.S. the commodity sector the banking sector. It's like several smaller crises could combine into one big crisis."
The flight from risk told on most Asian shares, with Hong Kong .HSI - a favourite channel for global investors to play China - diving 4.2 percent as investors there returned from the long Lunar New year holidays. Mainland China markets are closed all week.
MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS shed 1.4 percent, and South Korea .KS11 resumed with a 2.9 percent drop.
Wall Street had ended Wednesday mixed after Fed Chair Janet Yellen sounded optimistic on the U.S. economy, but acknowledged risks from market turmoil and a slowdown in China. took that to mean a hike in March was unlikely, but further tightening remained possible later in the year.
"Yellen made it clear that while the Fed still expects to continue on its gradual tightening path, policy was not on a pre-set course and would respond appropriately to developments," said Justin Fabo, a senior economist at ANZ.
"The real test may come later, if markets continue to deteriorate and look to central banks to save them. Are policymakers' guns loaded with blanks?"
YIELDS STEAM ROLLERED
It seemed some were already preparing for the worst.
Longer-term U.S. debt rallied hard as investors wagered that either the Fed would be unable to tighten at even a gradual pace, or that if it did hike it would only hasten the arrival of recession and deflation.
In a marked turnaround, yields on 10-year Treasuries fell to 1.6330 percent US10YT=TWEB , from a top of 1.773, almost exactly matching the lowest close from May 2013. Futures TYc1 imply further price gains lie ahead.
As a result, the spread over two-year paper US2YT=TWEB shrank to just 96 basis points, the smallest gap since late 2007 just before the global financial crisis hit.
Likewise, Fed fund futures 0#FF: are pricing in the shallowest of shallow tightening paths. The market implies a rate of 45 basis points for the end of this year, 60 basis points at the end of 2017 and 90 by the close of 2018.
The inexorable decline in U.S. yields continued to drag on the dollar, which reached lows last seen in October against a basket of currencies .DXY .
The yen was again lifted by safe-haven flows, as befits Japan's position as the world's largest creditor nation. The dollar sliced down through 111.36 yen to reach depths not delved since October 2014 at 110.99 JPY=EBS .
The euro also weakened against its Japanese peer, sliding to a 2-1/2 year low of 126.06 yen EURJPY=R . Against the greenback though, the euro drove to three-month high of $1.1355.
The aversion to risk helped lift gold XAU= as far as $1,217.00 an ounce, clearing stiff resistance around $1,200.
Oil prices resumed their decline as U.S. crude CLc1 slid 70 cents to $26.77 a barrel, while Brent futures LCOc1 lost 33 cents to $30.50.