* US 10-yr yield holds above 3 pct after surge
* Italian markets jolted by 5-Star, League coalition proposals
* Wall St gains, small-cap Russell hits record
* Dollar extends rally, euro weak (Updates with afternoon trading)
By Lewis Krauskopf
NEW YORK, May 16 (Reuters) - Italy's borrowing costs jumped on Wednesday and the country's stocks slid after reports that the two parties seeking to form Italy's next government might seek debt forgiveness, while the U.S. dollar rallied further to a five-month high.
Wall Street's main stock indexes gained, with the Russell 2000 small-cap benchmark hitting an intraday record high.
Investors were digesting Tuesday's surge in U.S. bond yields on the heels of a retail sales report that fueled the dollar and hurt stocks.
The benchmark 10-year yield held well above 3 percent after bursting through key technical levels on Tuesday.
“The combination of higher oil prices, higher dollar and stronger yields are starting to potentially weigh on investor sentiment,” said Katie Nixon, chief investment officer for wealth management division of Northern Trust in Chicago.
“As yields go up, they start to be a little bit more competitive with risk assets and with stocks in particular.”
The Dow Jones Industrial Average rose 74 points, or 0.3 percent, to 24,780.41, the S&P 500 gained 13.39 points, or 0.49 percent, to 2,724.84 and the Nasdaq Composite added 51.07 points, or 0.69 percent, to 7,402.70.
Shares of U.S. retailers rose after results from department store chain Macy's.
The Russell 2000 was up 1.1 percent and set its first intraday record high since Jan. 24.
In Italy, investors seized on a report that the anti-establishment 5-Star Movement and the far-right League party plan to ask the European Central Bank to forgive 250 billion euros ($296 billion) of Italian debt, according to a draft the parties are working on.
Italian stocks tumbled 2.3 percent while Italy's 10-year bond yield jumped nearly 19 basis points to 2.13 percent .
"It's right to resonate with markets because it tells you about the sense of the wisdom between these negotiating parties," said Chris Scicluna, head of economic research at Daiwa Capital Markets.
Other major European stock markets were higher, and the pan-European FTSEurofirst 300 index rose 0.19 percent, supported by the weaker euro.
MSCI's gauge of stocks across the globe gained 0.26 percent.
North Korea threw next month's summit between Kim Jong Un and U.S. President Donald Trump into doubt by saying it may reconsider if Washington insists it unilaterally gives up its nuclear weapons.
"Investors have gotten sort of used to this. Whether we are talking about North Korea or the trade discussions with China ... I think investors are recognizing we are at the beginning of the beginning of this, so it’s not anything to make dramatic portfolio moves or any significant bets on,” Nixon said.
U.S. Treasury yields were little changed with the 10-year yield hovering near a seven-year high.
Benchmark 10-year notes last fell 2/32 in price to yield 3.0853 percent, from 3.08 percent late on Tuesday.
The dollar index, which measures the greenback against a basket of six other currencies, rose 0.13 percent to 93.340 after rising to 93.632 during the session, its highest since mid December. The euro was down 0.27 percent to $1.1805.
U.S. crude fell 0.25 percent to $71.13 per barrel and Brent was last at $78.71, up 0.36 percent on the day.
Additional reporting by Tommy Wilkes and Dhara Ranasinghe in London, Danilo Masoni in Milan Editing by Susan Thomas and Nick Zieminski