Stocks, bonds rally after Fed keeps rates steady

The share price indicator for Macquarie Group is seen in red on the Australian Stock Exchange (ASX) board in central Sydney February 9, 2010.

NEW YORK (Reuters) - Stocks and bonds rallied on Tuesday, with the Standard & Poor's 500 closing at a near 1-1/2 year high after the United States kept monetary policy unchanged, with a nod to an improving economic recovery.

However, the Federal Reserve's pledge to leave interest rates near zero for an extended period of time accelerated the U.S. dollar's decline and helped lift the euro and yen to fresh session highs.

The weaker dollar also spurred a more than 2 percent rise in the price of crude oil, a move that comes a day before an OPEC meeting where investors expect no change in output targets but a push for better compliance.

The Fed left rates in a range between zero and 0.25 percent but the vote was not unanimous, with Kansas City Federal Reserve Bank President Thomas Hoenig dissenting for a second meeting in a row.

"This is generally supportive for all asset classes on a near-term basis. By keeping a more stimulative stand, they are propping up the economy and asset valuations. That's good until the economy is self-sustaining. But that is not now," said Jason Pride, director of investment strategy at Glenmede in Philadelphia.

Global stocks were already higher before the Fed's widely expected decision, boosted with the help of Standard & Poor's decision to affirm Greece's BBB-plus credit rating.

S&P's decision to end its review for a ratings downgrade removed a potential blow to Greece's efforts to raise capital in international markets to plug a gaping fiscal shortfall. A modest improvement in German economic sentiment also helped the euro's fortunes.

At the close, the Dow Jones industrial average .DJI rose 43.83 points, or 0.41 percent, to 10,685.98. The Standard & Poor's 500 Index .SPX climbed 8.95 points, or 0.78 percent, to 1,159.46. The Nasdaq Composite Index .IXIC gained 15.80 points, or 0.67 percent, at 2,378.01.

Intel (INTC.O) helped lift the major indexes, gaining 3.97 percent to $22.01 after it released its newest server chips, preparing for an expected rise in demand. The Philadelphia semiconductor index .SOXX gained 2.69 percent.

In Europe, banking shares led markets higher with the pan-European FTSEurofirst 300 .FTEU3 gaining 0.96 percent to 1,061.17 points, recovering lost ground following S&P's decision on Greece.

"Sovereign debt problems are not a issue for equities anymore. The market realized that the problem will be addressed, so Greece is not an issue at this juncture," said Franz Wenzel, strategist at AXA Investment Managers, in Paris.

European energy shares rose with the higher crude oil prices, with Royal Dutch Shell (RDSa.L) rising 1.3 percent and Total (TOTF.PA) up 0.6 percent.

MSCI's all-country world index .MIWD00000PUS rose 1.05 percent.

Japan's Nikkei closed 0.3 percent .N225 lower as the market took a breather day after hitting a seven-week high.

CURRENCIES

S&P ended its review for a downgrade for Greece, saying the government's recent deficit reduction measures are supportive of the ratings. Concerns about Greek debt have been a drag on equities in recent weeks.

The dollar fell against the euro in the wake of S&P's move as well as the decision by ministers of the 16-nation euro zone, which includes Greece, late on Monday to agree on ways that would permit aid for Greece to be rapidly rolled out, but gave no figures and few details.

European Union finance ministers on Tuesday backed the plans to help Greece financially.

"You have a slight improvement in risk because of the reported deal from the EU ministers to aid Greece, although the details are unclear," said Michael Malpede, market analyst at Easy Forex in Chicago.

The euro was also supported against the dollar and yen after the German ZEW institute's economic sentiment index came in higher than expected.

The greenback fell against a basket of major currencies, with the U.S. dollar index .DXY down 0.69 percent at 79.695.

The euro rose 0.7 percent at $1.3771 from a previous session close of $1.3673. Against the Japanese yen, the dollar fell 0.3 percent at 90.28 yen from a previous session close of 90.520.

The 10-year Greek government bond yield dropped as low as 6.183 percent from around 6.29 percent just before the S&P announcement, according to TradeWeb data, taking the spread over benchmark German Bund to 305 basis points from 315 basis points.

Benchmark 10-year U.S. Treasury notes were rose 12/32 of a point in price, pushing the yield down to 3.65 percent from 3.70 percent late on Monday.

Longer-dated Treasuries rose on the Fed's low rate stance, indicating it is not concerned about inflation, the bane of fixed income investments.

In commodity markets, U.S. light sweet crude oil settled up $1.90, or 2.38 percent, to $81.70 per barrel.

OPEC is expected to keep output unchanged at its Wednesday meeting in Vienna, with Saudi Arabia's oil minister saying the producers' group may not need to adjust output policy this year if the oil market remains stable.

Spot gold prices rose $19.45, or 1.76 percent, to $1,127.55.

(Additional reporting by Wanfeng Zhou, Ryan Vlastelica and Chris Reese in New York, George Matlock, Ian Chua, Tamawa Desai, Jessica Mortimer and Brian Gorman in London; Editing by Kenneth Barry)