U.S. stock futures fell more than 1 percent after the Fed raised its discount borrowing rate by a quarter percentage point.
Though the Fed cited improving market conditions for the decision, traders said it had come sooner than expected and moved the central bank one step closer to pushing up benchmark lending rates, which investors fear could rob the economy of some of its momentum and raise borrowing costs for consumers and companies.
The emergency easing cycle began with discount rate cuts -- it was all about easing liquidity to banks. So the move to raise the discount rate means the long journey toward (policy) normalization has begun, Robert Rennie, chief currency strategist at Westpac in Australia, said in a Reuters chat room.
The dollar index, a gauge of its performance against six major currencies, rose more than 1 percent to its highest level in eight months above 81.250 <.DXY> after the Fed move, which was announced after Wall Street stock markets had closed.
The euro fell around 0.5 percent to its lowest in 9 months, before clawing back some ground after St. Louis Federal Reserve President James Bullard, a voting member of the Fed's policymaking body, said market expectations for a policy rate hike this year were overblown.
Still, coming so soon after China unexpectedly increased banks' reserve requirements for the second time this year, the Fed's move worried investors, who have become quite comfortable with extraordinary amounts of money injected into banking systems during the financial crisis.
Investors have relied heavily on ultra-low interest rates to provide cheap money which they could shovel into higher-risk, higher-yielding assets such as equities and commodities.
As governments and central banks around the world start reeling that stimulus back in and tightening policy, markets are bound to turn more volatile, likely curbing returns.
BANKS STUNG AFTER FED
The MSCI index of Asia Pacific stocks outside Japan fell 1.6 percent <.MIAPJ0000PUS>, down for a second day, with banking stocks under particular pressure from the Fed move.
Hong Kong stocks led declines in the region, with the Hang Seng index down 2.2 percent <.HSI>. Shares of global bank HSBC <0005.HK> were the biggest drag on the index, down 1.5 percent on the day.
Japan's Nikkei share average <.N225> fell 1.3 percent <.N225>. Mizuho Financial Group <8411.T>, Japan's second-largest bank, saw its shares drop 2.3 percent, while shares of top bank Mitsubishi UFJ Financial Group <8306.T> fell 1 percent.
In the currency market, investors added to growing bets on the U.S. dollar and slashed bets on others, especially currencies of countries with poorer growth prospects.
The euro was down 0.3 percent to $1.3488 by midday in Asia and has dropped around 16 cents in the last two months, weighed down by Greece's debt problems and tepid euro zone economic growth. Earlier on Friday the single currency weakened to $1.3442, the lowest since May 18.
Sterling dropped 0.7 percent to $1.5435, also a 9-month low. In all likelihood, the Fed will keep winding down monetary stimulus, while the Bank of England may even have to extend its own growth friendly policies to shore up a patchy economic recovery.
We think that the Fed discount rate hike will lead to more USD strength as the market expects the Fed to start thinking about hiking the Fed Funds rate this summer, UBS strategists said in a note, recommending investors to sell sterling and buy dollars.
Shorter-term U.S. bond yields were also supportive of the dollar.
The yield on the 2-year U.S. Treasury note, which is sensitive to policy rates, rose in choppy trade to a 1-month high of 0.9724 percent before settling back at 0.9277 percent.
Investors were shifting from the shorter-end to longer- maturity Treasuries, causing the difference between yields to narrow. The spread of the benchmark 10-year yield over 2-year yields narrowed 5 basis points to 282 basis points, though remains not too far from historic steepness at 288 basis points.
March U.S. crude futures were down 1.3 percent to $78.04 a barrel, hurt by dollar strength that rocked commodities across the board.
Gold in the spot market was down 0.6 percent at $1,104.75 an ounce and has declined more than 6 percent since December.
(Editing by Kim Coghill)