NEW YORK (Reuters) - U.S. stocks and the dollar turned higher on Tuesday as investors bet the Federal Reserve will cut interest rates to calm worries related to insurer AIG, the latest company to be squeezed by a global credit crisis.

Wall Street fell prey to speculation about a possible rescue of American International Group after disappointing quarterly results from Goldman Sachs Group Inc failed to lift the deep gloom over financial markets.

Talk of a possible U.S. interest rate cut later in the day kept investors on edge a day after the U.S. government failed to provide a lifeline to Lehman Brothers, forcing an icon of Wall Street to file for bankruptcy protection.

Central banks flooded money markets with cash to encourage bank lending amid widespread credit concerns, while government debt prices jumped on heightened fears about global finances.

Yields on the 30-year U.S. Treasury bonds fell below 4 percent for the first time since the early 1960s.

Bund futures rallied more than a full point to as high as 116.13, its strongest level since mid-April.

Oil fell more than 4 percent to a seven-month low on rising concern that market turmoil will further undermine demand and send investors into safer havens. Reports that U.S. oil infrastructure had escaped major damage from Hurricane Ike helped push crude prices down.

U.S. stocks briefly turned positive and European shares pared losses after CNBC television, citing sources familiar with the matter, said a government role in an AIG bailout was being discussed but that no resolution had been reached.

Sentiment brightened on hopes the Fed would cut interest rates to calm turbulent financial markets. Fed policy-makers were set to make an announcement at the end of a scheduled meeting at 2:15 p.m. (7:15 p.m. British time).

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“I don’t think an interest rate cut is really necessary, but what they say is damn important,” said Hugh Johnson, chief investment officer at Johnson Illington Advisors in Albany, New York. “What’s important is some statement to the effect that the Federal Reserve stands prepared to exercise its lender-of-last-resort function to bring stability to the financial markets.”

Shortly before 1 p.m., the Dow Jones industrial average was up 23.53 points, or 0.22 percent, at 10,941.04. The Standard & Poor’s 500 Index was up 1.66 points, or 0.14 percent, at 1,194.36. The Nasdaq Composite Index was up 1.76 points, or 0.08 percent, at 2,181.67.

Shares of AIG were down 35 percent at $3.09, having been down as much as 68 percent earlier, following a slide of more than 60 percent on Monday.

European shares fell to their lowest close since May 2005 as investors grew more jittery about AIG’s fate and commodity stocks tracked sharply lower metal and oil prices.

The FTSEurofirst 300 index of top European companies closed 2.5 percent lower at 1,091.50 points, after a 3.6 percent tumble on Monday. It is down about 28 percent so far this year.

“Europe is just a residual on what is going on in the U.S. All eyes are on AIG and whether they can drum up the money tonight to keep them from going bankrupt,” said Philip Lawlor, chief portfolio strategist at Nomura.

In Europe, banks were the top negative weight on the index, with top British mortgage lender HBOS down almost 22 percent and Royal Bank of Scotland down around 10 percent.

Tame readings on U.S. consumer prices in September and tumbling oil prices helped assuage inflation worries and reinforced the view that Fed policy-makers will turn their focus to the market turmoil.

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The benchmark 10-year U.S. Treasury note rose 5/32 to yield 3.39 percent. The 30-year U.S. Treasury bond rose 12/32 to yield 4.02 percent.

The dollar rose against major currencies, with the U.S. Dollar Index up 0.68 percent at 79.017. Against the yen, the dollar was down 0.41 percent at 104.96.

Analysts said that despite much of the bad news originating in the United States, the dollar benefited from the widespread financial jitters as investors, particularly those from the United States, became increasingly keen to send money back home for safety.

“I expect the dollar’s upswing to continue. The major driver behind this is a massive repatriation of foreign-based U.S. investments including those from foreign funds,” said Adam Fazio, a senior currency strategist, at CIBC World Markets in New York.

The euro was down 0.81 percent at $1.4149.

U.S. light sweet crude oil fell 5.1 percent to $90.82 a barrel.

Gold earlier fell nearly 2 percent alongside a sharp drop in oil, turned higher, then fell again. Spot gold prices fell $9.20 to $777.00 an ounce.

Gold normally gains on safe-haven buying during financial crises, but portfolio managers have been selling assets across the board after Leman’s bankruptcy filing.

Platinum slipped more than 9 percent to its lowest level since October 2006 as a weakening global economy hit demand from auto makers. Platinum has lost half its value in the last six months from a record high of $2,290 an ounce in March.

Russia’s stock exchange suspended trade for one hour, with the MICEX index off 16.6 percent in the sharpest one-day percentage drop since the 1998 financial crisis, Reuters data showed. Liquidity fears drove the plunge, an exchange official said.

Asian shares plunged overnight, hit by a wave of selling in the financial sector. Tokyo’s Nikkei share average slumped 4.95 percent to its lowest level in three years. Japan’s top three lenders plunged, with No. 2 Mizuho Financial Group and No. 3 Sumitomo Mitsui Financial Group losing about 10 percent, their worst daily percentage drops in nearly five years. the Japanese market had been closed on Monday for a holiday.

MSCI’s index of Asia-Pacific stocks outside Japan fell 4.8 percent to the lowest level since August 2006. It is now down 44 percent from a peak last October.