* U.S. 10-year debt yield holds above 3 percent after surge
* Italian markets jolted by 5-Star, League coalition proposals
* Wall Street gains, small-cap Russell index hits record high
* U.S. industrial production rises strongly (Updates with close of U.S. markets)
By Lewis Krauskopf
NEW YORK, May 16 (Reuters) - The U.S. dollar rallied further to a five-month high on Wednesday, supported by relatively robust U.S. economic data in recent days, while Italy's borrowing costs jumped and its stocks slid on concerns linked to economic plans from the country's potential coalition government.
Wall Street's main stock indexes gained, with the Russell 2000 small-cap benchmark marking a 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 U.S. Treasury note yield held well above 3 percent after bursting through key technical levels on Tuesday. Data on Wednesday showed U.S. industrial production increased solidly in April, the latest indication that the economy was gathering momentum early in the second quarter.
“There is a lot of talk about the risks of interest rates and that’s real. But then there’s the question of why rates are rising and that’s faster growth,” said Brad McMillan, chief investment officer for Commonwealth Financial Network in Waltham, Massachusetts.
The Dow Jones Industrial Average rose 62.52 points, or 0.25 percent, to 24,768.93, the S&P 500 gained 11.01 points, or 0.41 percent, to 2,722.46 and the Nasdaq Composite added 46.67 points, or 0.63 percent, to 7,398.30.
Shares of U.S. retailers rose 0.5 percent after results from department store chain Macy's, whose shares jumped 10.8 percent.
The Russell 2000 rose 1.0 percent and set its first record high since late January.
“For small caps, they are not exposed to a lot of the risks that larger caps are facing,” McMillan said.
Italy's two anti-system parties appeared on the verge of clinching a deal to form a coalition government, rattling markets with radical ideas to free up billions of euros for tax cuts and welfare.
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 0.17 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,” said Katie Nixon, chief investment officer for the wealth management division of Northern Trust in Chicago.
U.S. Treasury yields ended slightly higher, with the 10-year yield touching near a seven-year high.
Benchmark 10-year notes last fell 6/32 in price to yield 3.1001 percent, from 3.08 percent late on Tuesday.
The dollar index, which measures the greenback against a basket of six other currencies, rose 0.16 percent to 93.365 after rising to 93.632 during the session, its highest since mid-December. The euro was down 0.26 percent to $1.1806.
Oil prices gained after an inventory report showed U.S. crude and gasoline stocks fell more than expected.
U.S. crude settled up 0.25 percent at $71.49 a barrel, while benchmark Brent settled at $79.28, up 1.08 percent.
Additional reporting by Tommy Wilkes and Dhara Ranasinghe in London and Danilo Masoni in Milan Editing by Nick Zieminski and James Dalgleish