* Gauge of U.S. business spending plans increases confidence
* Fitch scales back chance of U.S. rating cut
* Caution ahead of U.S. GDP, payrolls reports
NEW YORK, Jan 28 (Reuters) - U.S. Treasuries prices dropped and crude oil rallied on Monday after a gauge of planned U.S. business spending rose in December, increasing optimism that the recovery in the world's largest economy was gaining traction.
But caution ahead of key data on the U.S. economy and the Federal Reserve's first policy meeting of the year helped keep a lid on Wall Street stocks despite a solid earnings report from Caterpillar.
Investor optimism got a small boost after rating agency Fitch scaled back the chance it will strip the United States of its AAA status, saying a recent deal on the country's debt limit removed the near-term risk of a downgrade.
But it was the Commerce Department report that set the tone on Monday, with an unexpected rise in December for non-defense capital goods orders excluding aircraft, a closely watched proxy for investment plans. The market had forecast a small drop.
The data on U.S. durable goods helped drive up euro zone blue chip stocks to 18-month peaks.
"Net-net this report actually winds up being modestly better from a GDP perspective," said Tom Porcelli, chief U.S. economist at RBC Global Markets in New York.
The U.S. government will release its first estimate on fourth-quarter gross domestic product growth on Wednesday.
The benchmark 10-year U.S. Treasury note was down 9/32, with the yield at 1.9793 percent.
Investors tend to sell lower risk assets such as U.S. government debt when expecting better economic growth.
U.S. Treasuries traded steady at lower price levels on Monday in the wake of an auction of $35 billion of two-year Treasury notes.
On Wall Street, the S&P 500 edged lower on Monday, after rising for eight straight days in its longest winning streak in eight years.
In addition to the Fed's two-day policy meeting on Tuesday and Wednesday and the GDP data, investors are awaiting the government's January labor market report on Friday.
The Dow Jones industrial average was up 3.13 points, or 0.02 percent, at 13,899.11. The Standard & Poor's 500 Index was down 1.38 points, or 0.09 percent, at 1,501.58. The Nasdaq Composite Index was up 7.66 points, or 0.24 percent, at 3,157.37.
"Markets don't go up in a straight line," said Garry Evans, global head of equity strategy at HSBC In London. "I think that people are realizing there could still be problems out there."
Adding to potential pitfalls ahead were signs from Washington that the $1.2 trillion in automatic spending cuts due to take effect by March 1 could go ahead, threatening confidence in the U.S. economy.
Fitch said a ratings downgrade was still likely later in the year if Washington failed to use the new breathing space to put in place a credible debt reduction plan.
MSCI's benchmark world share index was down 0.2 percent on Monday after a nearly 4.5 percent gain this month on signs of economic recovery in the United States, stabilization in the euro zone and accelerating growth in China.
European stocks slipped 0.2 percent, with the broad FTSEurofirst 300 index of top company shares hovering just under a two-year high.
Banks were the best performing sector in Europe, up 0.6 percent, as investors focused on areas of the market which still look relatively cheap.
EUROPEAN ECONOMY FLAT
Data from the European Central Bank served another reminder that the recent surge in financial markets is not being matched in the real economy.
Lending by banks to euro zone companies, consumers and home buyers contracted in December for an eighth straight month as recessions across much of the region sap the appetite to borrow and banks' willingness to lend.
"As of the end of 2012, there was no sign of improvement in credit flows," said Marie Diron, an economist who works on Ernst & Young's euro zone forecasts in London.
Data showing inflows to global equity funds slowed in the past week and comments from several major investment banks noting signs that the market may be reaching a natural top added to the caution.
The euro was down 0.1 percent against the dollar, after touching an 11-month high on Friday. The prospects of a member country being forced to leave the euro zone have all but vanished since the middle of last year, a survey released on Monday showed..
In commodity markets, Brent oil prices steadied near a three-month high at just over $113 a barrel before the Fed meeting and the U.S. employment data, which is expected to show more signs of recovery in the world's biggest oil consumer.
U.S. light sweet crude oil rose 53 cents, or 0.55 percent, to $96.41 per barrel.