* European markets open higher, S&P futures extend gains
* Reports China and U.S. quietly working to avoid trade war
* Currency investors dump dollar and yen, snap up euros (Adds European markets)
By Tom Pfeiffer
LONDON, March 27 (Reuters) - Stock markets jumped and the dollar fell on Tuesday as reports that the United States and China were negotiating to avert a trade war whetted investors' appetite for riskier assets.
The euro rose to a five week high against the U.S. currency and Japan's Nikkei share index enjoyed its best day in almost three months, jumping 2.3 percent.
The reports of behind-the-scenes talks between Washington and Beijing spurred optimism that President Donald Trump's protectionist shift is more about gaining leverage in trade talks than isolating the world's biggest economy with tariff barriers that would stifle global growth.
This helped offset news that the United States and many of its allies were expelling more than 100 Russian diplomats in retaliation for a nerve agent attack on a former Russian spy in Britain.
An equity rally that began late on Wall Street, where shares had their best day in 2-1/2 years, spilled over to Asia and then Europe, where the Stoxx 600 index was on track for its best day in seven weeks.
But some investors were not rushing to recalculate risks around Trump's America First trade agenda.
"He can flip flop quite a lot," said Lukas Daalder, chief investment officer at Robeco in Rotterdam. "The big problem is, how long will it take before new tweets and headlines that will change the sentiment again?"
He said he was underweight emerging market equities and the Nikkei and overweight other developed markets "based on the expectation that there will be more trade uncertainty".
White House officials are asking China to cut tariffs on imported cars, allow foreign majority ownership of financial services firms and buy more U.S.-made semiconductors, said a person familiar with the discussions.
Chinese Premier Li Keqiang pledged on Monday to maintain trade negotiations and ease access to American businesses.
The surge in stocks dragged on the Treasury market, which faces a record $294 billion of new supply this week. Yields on 10-year Treasury notes inched up to 2.848 percent, but remained short of last week's top at 2.90 percent.
In currency markets the reaction was to offload both the yen and the dollar. After a big gain on Monday, the euro added another 0.3 percent to hit $1.2473, leaving it less than one cent off a three-year high hit in mid-February.
Valentin Marinov, head of G10 FX strategy at Credit Agricole, said that the easing of trade fears had allowed investors to re-focus on whether the European Central Bank would tighten monetary policy faster than expected, and for large institutional investors to resume allocating more money to the euro zone after years of being underweight.
The improved mood on trade gave a fillip to industrial commodities, with copper and iron ore bouncing.
In oil markets, Brent crude added 23 cents to $70.33 a barrel.
Additional reporting by Tommy Wilkes; editing by David Stamp