Stocks fall, 2-year yields soar with rates, economy in focus

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By Sinéad Carew

NEW YORK (Reuters) - Wall Street indexes followed European stocks lower on Friday and short-dated Treasury yields soared while the dollar rose as investors braced for a U.S. interest rate hike next week and grew alarmed at signs of a global economic slowdown.

Souring the mood was a warning from FedEx Corp (NYSE:FDX) late on Thursday that a global demand slowdown accelerated at the end of August and was on pace to worsen in the November quarter, causing it to withdraw its financial forecasts.

The FedEx warning "set the tone for people being forced to take on board what they had been reluctant to take on board all along - that rates will be higher for longer," said Steven Ricchiuto, U.S. chief economist at Mizuho Securities USA.

The two-year U.S. Treasury yield, a bellwether for interest rate expectations, topped 3.9%. Coupled with a decline in the benchmark 10-year note, the yield curve inversion between the two notes - seen as a recession harbinger - widened further.

Traders were pricing in a 75% chance of a 75-basis-point (bps) rate hike and a 25% chance of 100 bps when the Fed meets next Wednesday. The Bank of Japan and Bank of England also meet next week.

The two-year's yield rose 1.5 basis points to 3.888% and the 10-year yield slid 3.9 basis points to 3.420%.

The gap between the two, which has inverted because the short end is higher than the long end, widened to -47.4 basis points.

In equities, declines were broad-based across major industries as the FedEx news fueled fears about the economy.

"The Fed will view the FedEx report as an indication that they are on the right path, rather than a warning that the Fed may be moving too aggressively," said Rick Meckler, a partner at Cherry Lane Investments in New Vernon, New Jersey. [.N]

The Dow Jones Industrial Average fell 239.77 points, or 0.77%, to 30,722.05; the S&P 500 lost 42.5 points, or 1.09%, to 3,858.85; and the Nasdaq Composite dropped 172.63 points, or 1.49%, to 11,379.72.

The pan-European STOXX 600 index lost 1.24% and MSCI's gauge of stocks across the globe shed 1.19%.

Earlier in the day, the European Central Bank's vice president said an economic slowdown in the euro zone would not be enough to control inflation and the bank will have to keep raising rates.

The dollar index rose 0.009%, with the euro down 0.05% to $0.9994.

The Japanese yen strengthened 0.36% versus the greenback at 143.00 per dollar, while Sterling was last trading at $1.1411, down 0.45% on the day. The pound had weakened to a new 37-year low against the U.S. dollar.

Analysts and fund managers said the yen could hurtle toward three-decade lows before year-end.

Trading in oil futures was volatile with U.S. crude rising and falling roughly 1% so far. It remained on track for a weekly decline on fears that hefty interest rate increases would curb global economic growth and fuel demand fuel. [O/R]

U.S. crude recently rose 0.31% to $85.36 per barrel and Brent was at $91.41, up 0.63% on the day.

In commodities, gold prices struggled for direction. Spot gold added 0.4% to $1,669.87 an ounce. U.S. gold futures fell 0.13% to $1,663.20 an ounce.