Asian shares fell on Wednesday after China's latest interest rate rise, but government bond yields rose and the dollar and Swiss franc eased as investors bet Beijing's policy tightening would not derail hopes of a sustained economic recovery.
Developed equity markets outperformed emerging ones, continuing a rotation of funds that has been in place since the start of the year, although some analysts predicted strong Asian growth would reverse the trend eventually.
U.S. S&P 500 futures fell 0.3 percent and financial spreadbetters were calling major European markets to open flat-to-lower. On Tuesday, the Dow Jones industrial average <.DJI> notched a seventh straight day of gains, rising 0.6 percent, as surprisingly strong sales by McDonald's boosted optimism about consumer spending.
Technical indicators show the average is overbought after a strong run-up that began in September, leaving U.S. markets prone to a pullback or a correction.
China raised interest rates by 25 basis points late on Tuesday, its second increase in just over six weeks. The timing was a surprise, coming on the final day of the Lunar New Year holiday, but investors had been expecting further tightening from Beijing to rein in stubbornly high inflation.
Chinese policymakers' efforts to rein in overheating pressures are now seen in a relatively more positive light by global investors in that they will help slow growth to a more sustainable pace, while other engines of growth in the region begin to rev up, said Samarjit Shankar, analyst at BNY Mellon.
Japan's Nikkei <.N225> hit a 9-month high before retreating to close down 0.2 percent as bank shares were hit by profit-taking, but Australia's benchmark index <.AXJO> rose 0.3 percent and New Zealand shares also gained. <.T> <.AX>
MSCI's index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 0.8 percent, weighed down by a 1.2 percent decline in South Korean stocks <.KS11>, with market players citing weakness in firms such as Hyundai Motor <005380.KS> that are most exposed to China and a stronger won.
The Chinese rate hike had been expected for some time, said Lee Sun-yeb, a market analyst at Shinhan Investment Corp in Seoul. However, investors are reacting to it by offloading issues that are sensitive to forex swings and Chinese demand.
Chinese shares also fell, with the mainland market <.SSEC> down 1 percent and Hong Kong's Hang Seng <.HSI> off 0.6 percent.
Japan has been Asia's best performing market so far this year as healthier corporate profits and worries about building inflationary pressures have encouraged investors to switch money from fast-growing emerging markets -- last year's star performers -- to developed market equities.
I expect developed markets to outperform for a few months but Asia and emerging markets should come back with a vengeance in the second-half of the year, said Khiem Do, chairman of the Asia multi-asset team at Barings Asset Management in Hong Kong.
While monetary policy in the rich world remains ultra-loose, central banks in emerging markets, especially in Asia, have been tightening policy to rein in inflation fueled by rising commodity and energy prices and strong domestic growth.
Indonesia raised rates last week and South Korea is expected to announce a back-to-back rate increase on Friday, while central banks in India and Brazil both hiked last month.
Traders said markets were positioned for more rate hikes in China and Indonesia, but some others such as India and Korea are beginning to look attractive from a fixed income perspective as markets may be bracing for a lot more rate increases than what may be ultimately delivered.
INFLATION STILL IN FOCUS
The Swiss franc, seen as a safe-haven currency, fell across the board on Wednesday and the dollar index <.DXY>, which measures the U.S. currency against a basket of major currencies, slipped 0.1 percent.
Foreign exchange strategists said China's rate rise could support Asian currencies by underscoring policymakers determination to keep a lid on inflation.
The recent moves by China will give more room for other Asian countries to raise rates and regional equity markets will react negatively to this, said Wilfred Sit, Head of Asia Pacific Investment Strategy, Mirae Asset Global Investments (HK) Limited. Other more freely floating Asian currencies will continue to appreciate.
Increased investor appetite for riskier assets was evident in the bond market, with the five-year Japanese government bond yield climbing to a 15-month high and 10-year U.S. Treasury yields at a 9-month high, continuing a global trend of rising yields on government debt on expectations of an improving economy.
The market seems to want to price in a rate hike by the Federal Reserve, said a trader at a Japanese bank.
Gold, often seen as an inflation hedge, was little changed around $1,363 an ounce, after rising around 1 percent in the previous session.
U.S. crude oil futures rose 44 cents to $87.38 a barrel after U.S. data showed an unexpected drawdown in stocks.
News of China's rate hike hit commodities markets in London and New York initially, but prices soon rebounded as investors felt the size of the increase was not enough to stifle China's voracious demand for raw materials.
(Additional reporting by Vikram Subhedar, Jongwoo Cheon and Saikat Chatterjee; Editing by Kim Coghill)