GLOBAL MARKETS--Dollar upbeat on rate rise expectations, bonds fall

Thu Mar 20, 2014 5:16am EDT

* Dollar steadies at higher levels on U.S. rate rise expectations

* European, Asian, emerging market stocks fall

* Bund futures drop, following losses in U.S. Treasuries

* China's yuan skids to its lowest in a year

By Carolyn Cohn

LONDON, March 20 (Reuters) - The dollar steadied at higher levels on Thursday and stocks and bonds fell across the globe as investors positioned for U.S. interest rates to rise sooner and faster than previously thought.

Global stocks as measured by the MSCI world equity index dropped 0.6 percent, adding to the previous day's losses after Federal Reserve Chair Janet Yellen said the U.S. central bank might end its bond-buying program this autumn, and could start to raise interest rates around six months later.

Combined with a slight rise in the projected path for rates by Fed members, that led the market to bring forward the likely timing of the first hike in U.S. rates by a couple of months.

The whiplash was felt most in the short end of the Treasury market which is more sensitive to the course of the Fed funds rate. Yields on two-year notes shot up 8 basis points on Wednesday to 43 basis points, the sharpest single-day rise since mid 2011, and were trading at 42 bps on Thursday.

European stocks dropped 0.4 percent on Thursday, following losses of more than 1.5 percent in Japan and other Asian markets.

Yellen sought to use her news conference to emphasize that rates would stay low for a while and rise only gradually, but the message was lost on skittish markets.

Her words led the futures market for the U.S. Fed funds rate <0#FF:> to shift to pricing in around a 50-50 chance of the first hike in May to June next year. The timing had been July to August beforehand.

Yet many were not convinced the timetable had moved much at all. A Reuters poll of 17 primary dealers found 10 still expected the first hike to come in the second half of 2015, and four were still tipping 2016.

"Looking at the performance of markets this morning, there is no real followthrough," said Simon Derrick, a currency strategist with Bank of New York Mellon.

"People are looking for reasons why the range should break. I don't think Yellen was the thing to do it."

Yields on 10-year notes were at 2.76 percent, having risen 9 basis points on Wednesday. German Bund futures , the benchmark for European bonds, fell 60 ticks.

The rise in U.S. yields in turn helped lift the dollar and sent the euro reeling back a full cent on Wednesday. But the dollar steadied at $1.3826 on Thursday. Against a basket of major currencies, the dollar was holding at 79.993 after adding 0.8 percent on Wednesday.

The U.S. currency was slightly up at 102.42 yen, having jumped a full yen on Thursday and away from important chart support in the 101.20/30 zone.

The dollar's gains were gold's undoing, sending the metal down to three-week lows of $1,319.61 an ounce.

The prospect of rising rates in the United States has not been good for some emerging markets as it threatens to draw capital away, pressuring equities and currencies.

Emerging stocks fell more than 1 percent on Thursday to the week's lows, within sight of their worst level in six-weeks.

The rate rise expectations also come as China seems to be weakening its yuan as a way to support a slowing economy, which puts pressure on other nations in the region to lower their currencies to stay competitive on exports.

The yuan skidded 1.33 percent below the daily midpoint fixing to its lowest in a year at 6.2275 per dollar, a long way from where it started the year at 6.0515 and a huge move for the normally tightly-controlled currency.

Last weekend, the People's Bank of China (PBOC) doubled the daily trading band allowed for the yuan to 2 percent from the mid-point that it sets each day.

In oil markets, Brent futures fell 21 cents to six-week lows of $105.62 per barrel, while U.S. crude oil added 2 cents to $100.39. (Additional reporting by Wayne Cole in Sydney and Patrick Graham in London; Editing by Toby Chopra)

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