December 14, 2016 / 11:08 PM / in 7 months

Dollar, bond yields gain on Fed rate outlook

U.S. dollar notes are seen in this November 7, 2016 picture illustration. .Dado Ruvic/Illustration/File Photo

NEW YORK (Reuters) - The dollar hit a 14-year high and bond yields rose broadly on Thursday, extending gains from a day earlier when the Federal Reserve hiked U.S. interest rates and signalled 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 bank shares, while gold fell to a 10-1/2-month low.

The Fed's rate rise of 25 basis points 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.

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.

"The dollar is reacting very strongly while (bond prices) have continued to struggle and also gold. The combination of those three tell you that interest rates are likely to continue their trajectory higher," said Paul Nolte, portfolio manager at Kingsview Asset Management in Chicago.

"The thought is that earnings will be better and the economy is strong enough to be able to withstand higher interest rates, and that is why we're not seeing a decline in stocks," he said. "That being said, the stronger dollar and higher interest rates will at some point filter through to earnings. It's just a matter of when and how."

The dollar index .DXY, which measures the greenback against a basket of six major rival currencies, rose to a roughly 14-year high of 103.560, on track for the biggest daily percentage gain in nearly six months.

Bank shares helped lift stock indexes on the prospect of a boost to their profits. The S&P financial index .SPSY ended up 1 percent. The Dow Jones industrial average again neared the 20,000 mark.

The Dow Jones industrial average .DJI closed up 59.71 points, or 0.3 percent, to 19,852.24, the S&P 500 .SPX gained 8.75 points, or 0.39 percent, to 2,262.03 and the Nasdaq Composite .IXIC added 20.18 points, or 0.37 percent, to 5,456.86.

European shares .FTEU3, which ended up 1 percent, also rose with bank stocks, while MSCI's all-country world stock index .MIWD00000PUS was down 0.6 percent.

Bond markets saw yields on U.S. debt surge again on Thursday. Benchmark U.S. 10-year yields hit more than two-year highs, while yields on two-year notes touched more than a seven-year peak.

In late U.S. trading, 10-year prices were down 19/32 US10YT=RR, yielding 2.594 percent, up 7 basis points from levels late on Wednesday.

Emerging Markets on Edge

The Fed's anticipated policy path, and expectations that Trump will get economic growth motoring, are keeping emerging markets on edge as capital gets sucked from more fragile, export-dependent economies toward dollar-based assets. Emerging market stocks .MSCIEF fell 1.6 percent.

Mexico's central bank aggressively hiked its benchmark interest rate in a bid to cool quickening inflation after the peso MXN= fell to record lows after the U.S. election. Mexico's markets have been battered hardest by Trump's threats to tear up trade deals.

Among commodities, gold extended losses from the previous session, while oil ended little changed after sliding to its lowest level in a week in volatile trade.

U.S. crude CLc1 slipped 14 cents to settle at $50.90 per barrel, while Brent LCOc1 futures gained 12 cents to settle at $54.02. Spot gold XAU= hit a 10-1/2-month low of $1,122.35 an ounce, and was last down 1.2 percent at $1,130.72.

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

Editing by Nick Zieminski and James Dalgleish

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