Developed and emerging markets diverge as Fed keeps rates steady

By David Gaffen

NEW YORK (Reuters) - Developed equity markets across the world fell on Friday and bonds rose, pushing yields sharply lower, after the U.S. Federal Reserve refrained from raising interest rates amid weakening global growth and recent financial market volatility.

Bucking that trend to advance were stocks and currencies in emerging markets, which are more vulnerable to higher U.S. interest rates and welcomed the Fed's Thursday decision to postpone "lift-off" on rate hikes for at least another month.

Short-term lending rates, used as proxies for market expectations for the Fed's next move, shifted dramatically. December's fed funds futures contract rose to drop its yield to 21.5 basis points, implying only about a 42 percent chance of a rate increase by the end of the year.

"Investors are wrestling with how concerned they should be regarding global growth," said Jeremy Zirin, chief equity strategist at UBS Wealth Management.

"The Fed has introduced a quasi-third mandate about the global growth, apart from the labour market and inflation."

U.S. debt yields remained under downward pressure, though the short-dated two-year note's yield had bounced from earlier lows. It was at 0.7 percent, a day after it hit a four-and-a-half-year high of 0.819 percent.

U.S. stocks weakened, following other developed markets. The Dow Jones industrial average fell 183.19 points, or 1.1 percent, to 16,491.55, the S&P 500 lost 18.18 points, or 0.91 percent, to 1,972.02 and the Nasdaq Composite dropped 32.34 points, or 0.66 percent, to 4,861.61.

The FTSEuroFirst index of leading 300 shares slid 1.9 percent to 1,396 points , its biggest fall in two weeks.

Japan's Nikkei average <.N225> fell 2 percent.

European government bond yields tumbled, tracking the 2-year U.S. Treasury yield's biggest fall since 2009. The 10-year German Bund yield was down 12 basis points to 66 basis points, on course for its biggest one-day fall since early July.

YEAR-END RATE HIKE?

A growing number of economists are now wondering whether the Fed will raise rates at all this year. A Reuters poll of the primary dealers in Treasury securities showed 12 of 17 now see the first rate increase in December.

Fed Chair Janet Yellen said the global outlook appeared less certain, adding that recent falls in U.S. stock prices and a rise in the value of the dollar were already tightening U.S. financial market conditions.

Emerging market equities rose to one-month highs on Friday, with MSCI's broadest emerging market index <.MSCIEF> up 0.3 percent and on track for the biggest weekly rise since early April.

The dollar recovered a little after falling more than 1 percent following the Fed's decision. The dollar index against a basket of major currencies was up 0.2 percent at 94.756.

The euro gave up earlier gains, falling from a three-week high of $1.1459 earlier to $1.1368, down 0.6 percent. The dollar fell 0.1 percent against the yen to 119.84 yen .

U.S. crude futures were down 3.4 percent at $45.28 per barrel. Brent fell 2.1 percent to $48.05 a barrel .

Gold rose to a near three-week high. Spot gold was up 0.7 percent at $1,138.86 an ounce, after earlier hitting $1,141.30.

(Additional reporting by Jamie McGeever in London; Editing by Nick Zieminski and Bernadette Baum)