By Herbert Lash
NEW YORK (Reuters) -Treasury yields and a gauge of global equities fell sharply after the Federal Reserve left interest rates unchanged as expected on Wednesday but indicated it would not reduce them until inflation was "moving sustainably" towards its 2% target.
The Fed took a major step towards lowering rates in coming months in a policy statement that tempered inflation concerns with other risks to the U.S. economy and dropped a longstanding reference to possible further hikes in borrowing costs.
The dollar rose against the euro and other major currencies after Fed Chair Jerome Powell at a press conference said that a rate cut in March was not the U.S. central bank's "base case," comments that were less dovish than many investors had expected.
First and foremost, the Fed wanted to double down on its inflation fighting credibility, said Michael Arone, chief investment strategist for State Street’s U.S. SPDR business in Boston.
"That's a signal to the market that it shouldn't get ahead of itself on the potential for all these rate cuts" that had been priced in to the market, Arone said.
"They also wanted to balance that with the notion that they do believe that it will be appropriate to cut rates later this year."
With no indication of rate reductions soon, futures pared bets for a cut in March to 33.5% from almost 90% at year-end 2023 and increased the likelihood to almost 90% when the Fed meets in May, according to CME Group's (NASDAQ:CME) FedWatch Tool.
MSCI's gauge of stocks across the globe lost 0.92% and stocks on Wall Street closed sharply lower, already weighed down by weakness in tech and other megacap stocks the day after disappointing results from Google-parent Alphabet (NASDAQ:GOOGL).
The tech-rich Nasdaq was down 2.23%, the S&P 500 lost 1.61% and the Dow Jones Industrial Average fell 0.82%.
"The good news is we can forget about any more tightening. The bad news it's 'when', not 'if', they're going to cut rates, and that 'when' has been pushed out to what had been the fringes of consensus," said Art Hogan, chief market strategist at B. Riley Wealth in New York.
In Europe shares rose slightly, with the pan-regional STOXX 600 index earlier closing up 0.01%, lifted by robust corporate updates and strong market performances in Spain and Italy.
The dollar index, which has gained almost 2% against a basket of major currencies this month in its biggest advance since September, slid earlier against the euro and yen as traders awaited the Fed's statement. It later rose 0.15%.
The euro fell 0.26% to $1.0812 and the yen strengthened 0.47% at 146.90 per dollar and was on course for a monthly decline of 4.5%, which would be its largest monthly drop since June 2022.
Treasury yields slid to near three-week lows and the benchmark 10-year note posted its largest daily loss since December on the Fed's no rate-cut soon stance.
The two-year Treasury yield, which reflects interest rate expectations, fell 14.4 basis points to 4.215%, while the 10-year's yield slid 13.1 basis points at 3.926%.
Euro zone government bond yields dropped after mixed economic data from Germany and France, and dovish comments from European Central Bank officials.
Germany's 10-year government bond yield, the benchmark for the euro area, fell 9.7 basis points to 2.177%.
Other market moves were largely subdued as traders stayed on guard ahead of the Fed decision.
Earlier China's blue-chip index lost 0.9% after a survey showed manufacturing activity shrinking in January for a fourth month.
That dragged MSCI's broadest index of Asia-Pacific shares outside Japan down 0.4%, and it was heading for a monthly loss of roughly 5%, snapping a two-month winning streak.
In Japan though, the Nikkei ended the month with a more than 8% gain, its best January performance since 1998.
Oil prices settled lower, pressured by low economic activity in leading crude importer China and a surprise build in U.S. crude inventories as producers ramped up output following frigid weather this month.
Brent crude futures for March, which expire on Wednesday, settled down $1.16 at $81.71 a barrel. U.S. West Texas Intermediate crude futures fell $1.97 to settle at $75.85.
U.S. gold futures settled 0.8% higher at $2067.40 an ounce.