* Asian stock markets : tmsnrt.rs/2zpUAr4
* Treasuries rally, 2-year yields below Fed rates
* Dollar on defensive vs yen
* Safe-haven gold near 6-1/2 month peak
By Swati Pandey
SYDNEY, Jan 4 (Reuters) - Global markets were on edge on Friday as dire U.S. economic data slammed Wall Street and pushed investors to bet the Federal Reserve could reverse its policy tightening before the end of this year.
Fears the Sino-U.S. trade battle would drag down world growth roiled risk-sensitive assets in 2018, driving a surge in volatility and sending major stock markets deep into the red.
Those worries found some basis this week as Apple Inc cut its revenue forecast for the first time in nearly 12 years, blaming weaker iPhone sales in China. Its shares crashed nearly 10 percent overnight.
That followed Thursday's disappointing survey data from the Institute for Supply Management (ISM), which showed U.S. factory activity slowed more than expected in December.
The dismal report drove investors to the safety of bonds. Yields on the two-year Treasuries sank below 2.4 percent to reach parity with the federal funds effective rate for the first time since 2008.
Three- and five-year yields were even lower, an inversion that has sometimes heralded recessions in the past. Yields on 10-year benchmark paper dropped to 2.55 percent, a staggering turnaround from the highs of 3.25 percent seen as recently as November.
The falls kept the dollar on the defensive. The greenback plumbed a more than nine-month low of 105.25 against the safe-haven yen on Thursday, driven by technical factors amid thin holiday trade.
It has fallen more than 2 percent so far this week, the biggest weekly loss since last February. The risk-sensitive Australian dollar hovered near a two-year trough at $0.7005.
"The ISM manufacturing index tumbled more than five points. A drop of this magnitude has only been seen four times since 1980, three of which the economy was in the midst of recession," said Michelle Girard, U.S. economist at RBS.
"The ISM has a long track-record and big moves often prove to be meaningful. The December drop therefore gives pause, even to us economic optimists," Girard added.
"Now...a closely-watched indicator is flashing yellow, putting ourselves, and likely the U.S. Federal Reserve, on higher alert."
The Fed had raised rates a total six times through 2017 and 2018 to 2.00-2.25 percent as the U.S. economy galloped ahead, the jobless rate dived and inflation showed signs of picking up.
Investors had initially expected the policy tightening to continue through this year but the ongoing trade war and recent disappointing corporate earnings have put those expectations to rest.
The interest rates futures market also reacted sharply on Thursday with the December Fed funds contract surging 18 ticks to 97.77, implying a cash rate of just 2.23 percent. A couple of months ago, it was pricing in a rate of 3 percent.
Investors now see rates at 2.00 percent by the middle of next year.
"Whether this pessimism continues for the rest of 2019 will largely depend on whether there is a near-term resolution to the trade war," said Tapas Strickland, markets strategist for National Australia Bank.
"Some sort of truce should be more likely given recent market developments – data including the ISM suggests both China and the US will slow in 2019, effectively giving (the United States and China) little choice but to seek a truce."
Concerns about a U.S. recession whacked Wall Street overnight, with the Dow skidding 2.8 percent, the S&P 500 down 2.5 percent and Nasdaq losing more than 3 percent.
MSCI's gauge of stocks across the globe shed 1.4 percent on Thursday.
Keeping with the risk-off theme, gold prices hit a 6-1/2-month peak of $1.294.88 an ounce.
Reporting by Swati Pandey and Wayne Cole; Editing by Sam Holmes