Fed economic outlook spooks Wall Street; dollar rises

A man looks at the main hall of Warsaw Stock Exchange in Warsaw September 20, 2011.

NEW YORK (Reuters) - The Federal Reserve's warning that the United States faces a grim economic outlook jolted investors on Wednesday, driving down U.S. stocks more than 2 percent, while benchmark Treasury yields hit a more than 60-year low on the Fed's announcement of a $400 billion bond-buying program.

The dollar rallied against the euro and the yen, buoyed by the prospect of higher short-term rates as a result of the Fed's aim to push down longer-term interest rates by selling shorter-term notes and using the funds to buy longer-dated Treasuries.

The Fed's bond-buying program, dubbed Operation Twist, had been highly anticipated, but investors were spooked by the U.S. central bank's comment on the economy. The Fed, in its policy statement issued after the close of its two-day meeting, said, "There are significant downside risks to the economic outlook."

"That headline of economic outlook -- I don't know why people are surprised to read that -- but it seems to be what people are fixated on and that is what is driving the market lower," said Stephen Massocca, managing director at Wedbush Morgan in San Francisco.

On Wall Street, the three major indexes ended more than 2 percent lower. The Dow Jones industrial average .DJI was down 283.82 points, or 2.49 percent, at 11,124.84. The Standard & Poor's 500 Index .SPX was down 35.33 points, or 2.94 percent, at 1,166.76. The Nasdaq Composite Index .IXIC was down 52.05 points, or 2.01 percent, at 2,538.19.

The MSCI world equity index .MIWD00000PUS slipped 2.3 percent. The FTSEurofirst 300 index of pan-European stocks .FTEU3 ended down 1.7 percent, ahead of the Fed statement, while an index of emerging stocks .MSCIEF lost 1.6 percent.

Prices of long-dated U.S. Treasuries rallied. Benchmark 10-year note yields fell to a 60-year low of 1.87 percent, down from 1.95 percent before the statement.

Thirty-year bonds, the longest U.S. debt maturity, soared over three points in price with yields plunging to 3.01 percent, the lowest since January 2009.

"This is good for Treasuries," said Gennadiy Goldberg, interest rate strategist at 4Cast Inc in New York. "Whether this will create economic stimulus remains to be seen."

LONG DOLLARS

The euro last traded down 1 percent at $1.3569, while the dollar rose 0.4 percent to 76.70 yen.

"The Fed did the minimum of what investors expected, and they have been punished for it," said Kathy Lien, director of research at GFT in New York.

"Investors are losing confidence in the central bank because they keep on coming up short. They are now buying back dollars and positioning for a prolonged period of slower global growth."

Analysts said an important dollar-positive by-product of the Fed's program is higher short-term rates. Ongoing uncertainty about Europe's debt crisis should also buoy the dollar.

The euro had earlier gained after Greece outlined key measures to help alleviate the country's fiscal problems.

A Greek government spokesman said decisions taken on Wednesday would enable Greece to comply with all its obligations to the European Union and International Monetary Fund until 2014. The spokesman added that Greece will remain part of the euro zone.

The dollar also jumped to session highs against the Australian dollar and sterling after the Fed. The Aussie dollar last fell 2.2 percent to $1.0038, while sterling lost 1.5 percent to $1.5510.

U.S. crude oil fell $1 to settle at $85.92 a barrel as analysts deemed the Fed's easing measures insufficient to jump-start the economy. London Brent oil slipped 18 cents to settle at $110.36 a barrel.

Spot gold fell to $1,783 after the Fed.

(Additional reporting by Chuck Mikolajczak, Karen Brettell and Julie Haviv; Editing by Leslie Adler)