By Wayne Cole and Hideyuki Sano
SYDNEY/TOKYO (Reuters) - Asian shares and currencies softened on Thursday after the Federal Reserve raised rates for the first time in a year and hinted at the risk of a faster pace of tightening than investors were positioned for.
Yields on short-term U.S. debt surged to the highest since 2009, sending the dollar to peaks not seen in almost 14 years, which in turn prompted China's central bank to set the yuan at its weakest level against the greenback since 2008.
The Fed's anticipated policy path, and expectations U.S. President-elect Donald Trump will set growth on a higher gear, are keeping Asian policymakers on edge as capital gets sucked out from the fragile export-dependent regional economies toward dollar-based assets.
The Fed's rate rise of 25 basis points to 0.5-0.75 percent 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 markets were surprised by the dot plots. Given that the 10-year U.S. bond yield has risen above the key level of 2.5 percent, the sell-off in bonds is likely to continue," said Hiroko Iwaki, senior strategist at Mizuho Securities.
The change came even as the Fed's economic projections have hardly been upgraded, suggesting the Fed could accelerate tightening even further if policymakers see firmer evidence of higher growth or inflation.
"The U.S. economy is already on a solid expansion but the new administration wants to do large-scale spending. That could surely boost inflation and U.S. bond yields," said Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley (NYSE:MS) Securities.
Fed fund futures <0#FF:> slid to imply an almost 50 percent chance that the Fed will raise rates three times, with two hikes fully priced in already.
****************************************************************
For Reuters Graphic on the Fed, click on
http://tmsnrt.rs/2gsUVwB
****************************************************************
The 10-year U.S. Treasuries yields rose to 2.587 percent, having risen more than 0.7 percentage point since Trump was elected as the next U.S. President.
Yields on two-year Treasury paper jumped more than 10 basis points to 1.28 percent, the biggest daily increase since early 2015 and the highest level since August 2009. They stood at 1.267 percent in Asia.
EMERGING PRESSURE
It also took the premium that U.S. Treasuries pay over German two-year debt to its fattest since 2000.
The allure of higher U.S. yields raises risks for emerging markets in Asia and elsewhere, as funds look to take advantage of rising U.S. rates.
The Chinese central bank set the yuan mid-point at 6.9289 to the dollar, its weakest since June 2008, though market players noted that the yuan has been firmer against many other currencies and rose on trade-weighted basis.
The yuan promptly fell to its lowest levels in more than eight years, reflecting the weakening in the daily mid-point.
Low-yielding currencies such as the Singapore dollar and Korean won came under pressure, and analysts anticipate the low-yielders will be on the back foot in an environment of a rising dollar, higher U.S. yields and a depreciating yuan.
The challenges confronting Asia's policymakers from capital outflows was highlighted in Thursday's South Korean central bank meeting.
The Bank of Korea held its key policy rate steady at a record low of 1.25 percent and flagged growing risks for the export-reliant economy that some analysts feel should be tempered through another rate cut. But the BOK faces a dilemma as further easing could spark destabilising capital flows toward higher yielding U.S. dollar-based assets, forcing it to sit tight for now.
The Singapore dollar fell near its January low and is on the verge of slipping to its lowest September 2009.
Even high-yielding currencies in Asia could return some of their recent gains if investors shy away from risk, Citi analysts said in a note.
The U.S. dollar was already up across the board, hitting a near 14-year peak against a basket of currencies at 102.62.
The euro dropped to as low as $1.0468. A break below its March 2015 low of $1.0457 could open the way for a test of $1, or parity against the dollar, which last happened in late 2002.
The dollar rose to 117.86 yen, its highest level since early February, though that drop in the yen cushioned Japanese stocks, lifting Nikkei 0.1 percent.
MSCI's broadest index of Asia-Pacific shares outside Japan dropped 1.2 percent.
European shares are expected to be open slightly weaker, with spread-betters looking to a fall of 0.2 percent in Britain's FTSE and a 0.1 percent drop in Germany's DAX.
Wall Street suffered its biggest percentage decline since before the Nov. 8 U.S. presidential election, though the loss was slight compared with gains of the last month or so.
The Dow ended Wednesday down 0.6 percent, while the S&P 500 lost 0.81 percent and the Nasdaq 0.5 percent. (N)
Stocks have been on a tear in recent weeks on speculation the incoming Trump Administration will pursue tax cuts and increase infrastructure spending.
Oil prices stabilised as a tighter market looms in 2017 due to planned output cuts led by OPEC and Russia, after sharp declines earlier following the Fed's action. [O/R]
Brent crude futures traded at $53.89 per barrel, erasing gains made earlier in the week that had taken it a 1 1/2-year high.
Gold dropped to its lowest in more than 10 months around $1,135.1 an ounce and last stood at $1,141.9.