By Caroline Valetkevitch
NEW YORK (Reuters) - The dollar hit a 14-year high and bond yields rose broadly on Thursday, extending gains from a day earlier when the Federal Reserve hiked U.S. interest rates and signaled increases would follow at a faster pace next year.
U.S stocks bounced back from their biggest daily percentage decline in about two months, led by gains in bank shares, while gold hit its lowest since early February.
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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.
Fed fund futures <0#FF:> slid to imply an almost 50 percent chance that the Fed would raise rates three times in 2017, with two hikes fully priced in already.
The central bank's decision to raise rates comes as U.S. President-elect Donald Trump, who will be sworn in next month, is expected to cut taxes and boost spending on infrastructure.
"The dollar is reacting very strongly and (bond prices) have continued to struggle and also gold. the combination of those three tell you that interest rates are likely to continue their trajectory higher," said Paul Nolte, portfolio manager at Kingsview Asset Management in Chicago.
"The thought is that earnings will be better and the economy is strong enough to be able to withstand higher interest rates, and that is why we're not seeing a decline in stocks," he said. "That being said, the stronger dollar and higher interest rates will at some point filter through to earnings. It's just a matter of when and how."
The dollar index, which measures the greenback against a basket of six major rivals, was last up 1.3 percent after rising to 103.56, a 14-year high.
Bank shares helped lift stock indexes, on the prospect of a boost to their profits. The Dow Jones industrial average again neared the 20,000 mark.
The Dow Jones industrial average was up 68.42 points, or 0.35 percent, to 19,860.95, the S&P 500 gained 8.78 points, or 0.389654 percent, to 2,262.06 and the Nasdaq Composite added 18.44 points, or 0.34 percent, to 5,455.11.
European shares, which ended up 1 percent, also rose with bank stocks, while MSCI's all-country world stock index was down 0.6 percent.
Bond markets saw yields on short-term U.S. debt surge to multi-year highs.
The belly of the U.S. yield curve also climbed to multi-year peaks, with five-year notes rising to their strongest level in 5-1/2 years and seven-year notes hitting almost three-year highs. Yields on U.S. two-year notes touched more than seven-year peaks.
Benchmark 10-year U.S. Treasury note prices were down 19/32 in price to yield 2.594 percent.
Emerging market stocks fell 1.6 percent. The Fed's anticipated policy path, and expectations that Trump will get economic growth motoring, are keeping emerging markets on edge as capital gets sucked from more fragile, export-dependent economies toward dollar-based assets.
The allure of higher U.S. yields raises risks for emerging markets as funds look to take advantage of rising U.S. rates rather than put their money in traditionally riskier economies.
Mexico's central bank aggressively hiked its benchmark interest rate in a bid to cool quickening inflation after the peso fell to record lows after the U.S. election. Mexico's markets have been battered hardest by Trump's threats to tear up trade deals.
Among commodities, gold extended losses from the previous session, while U.S. crude oil ended down slightly as the dollar rallied.
U.S. crude slipped 14 cents to settle at $50.90 per barrel. Spot gold hit a 10-1/2-month low of $1,126.48 an ounce.
For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets
(Additional reporting by Marc Jones in London, Wayne Cole in Sydney and Hideyuki Sano in Tokyo; Editing by Nick Zieminski and James Dalgleish)