Dollar, bond yields advance on Fed rate hike

By Caroline Valetkevitch

NEW YORK (Reuters) - The dollar hit a 14-year high and government bond yields rose broadly on Thursday, extending gains from a day earlier when the Federal Reserve hiked U.S. interest rates and signaled increases would follow at a faster pace next year.

U.S stocks bounced back from their biggest daily percentage decline in about two months, led by gains in financial shares. The Dow Jones industrial average again neared the 20,000 mark.

The Fed's rate rise of 25 basis points to 0.5-0.75 percent was well-flagged, but investors were spooked when the "dot plots" of members' projections showed a median of three hikes next year, up from two previously.

Fed fund futures slid to imply an almost 50-percent chance that the Fed would raise rates three times, with two hikes fully priced in already.

The central bank's decision to raise rates comes as U.S. President-elect Donald Trump, who will be sworn in next month, is expected to cut taxes and boost spending on infrastructure.

"While there still remains a cloud of uncertainty over how economic policy may change under Trump's presidency, the same rising optimism towards Trump boosting U.S. growth through tax cuts and infrastructure spending may have played a key part in the changes to the Fed's projections," said Lukman Otunuga, a research analyst with FXTM.

The dollar index, which measures the greenback against a basket of six major rivals, was last up about 1.7 percent at 103.54, a 14-year high.

Bank shares helped lift stock indexes, on the prospect of a boost to their profits.

The Dow Jones industrial average was up 142.06 points, or 0.72 percent, to 19,934.59, the S&P 500 gained 15.79 points, or 0.700756 percent, to 2,269.07 and the Nasdaq Composite added 43.39 points, or 0.8 percent, to 5,480.07.

European shares, up 1 percent, also rose with bank stocks, while MSCI's all-country world stock index was down 0.5 percent.

Bond markets saw yields on short-term U.S. debt surge to multi-year highs.

The belly of the U.S. yield curve also climbed to multi-year peaks, with U.S. five-year notes rising to their strongest level in 5-1/2 years and seven-year notes hitting almost three-year highs. Yields on U.S. two-year notes touched more than seven-year peaks.

Benchmark 10-year Treasury prices were down 12/32, yielding 2.567 percent, up 4 basis points from levels late on Wednesday.

EMERGING PRESSURE

Emerging market stocks fell 1.8 percent. The Fed's anticipated policy path, and expectations that Trump will get growth motoring, are keeping emerging markets on edge as capital gets sucked from more fragile, export-dependent economies toward dollar-based assets.

The allure of higher U.S. yields raises risks for emerging markets, as funds look to take advantage of rising U.S. rates rather than put their money in traditionally riskier economies.

Currencies such as the Singapore dollar and Korean won came under pressure. Mexico, whose markets have been battered hardest by Trump's threats to tear up trade deals, holds a central bank meeting later, where it is expected to hike its own interest rates in response to the Fed and try to prevent further damage.

Among commodities, gold hit its lowest since early February, while oil prices fell as the dollar rallied.

For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

(Additional reporting by Marc Jones in London, Wayne Cole in Sydney and Hideyuki Sano in Tokyo; Editing by Tom Heneghan and Nick Zieminski)