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Stocks reversed course to rally sharply higher after MSCI's global stock index lurched to a July 2020 low and the dollar gave up strong gains as investors digested a red hot U.S. inflation reading that cemented bets for a big Federal Reserve rate hike next month.

Traders initially flipped to safety mode after the U.S Labor Department's consumer prices index (CPI) report showed headline CPI gaining at 8.2% annually as rents surged by the most since 1990 and the cost of food also rose. Core CPI, which excludes food and fuel prices, beat forecasts at 6.6%. 

On Wall Street the S&P 500 (.SPX) fell as much as 2.3% while Nasdaq dropped as much as 3.2% before both recovered their losses to soar higher. The euro had fallen as much as 0.72% against the dollar after the data as nervous investors turned to the safety of the greenback before turning higher.

"When you have that big of a shock that it moves that fast it's not unusual for it to get a little bit overdone. That might actually be a good sign we're not seeing follow-on selling," said Shawn Cruz, head trading strategist at TD Ameritrade in Chicago, Illinois.

While the data implies that the Fed will continue with sizeable rate hikes, Cruz said the market retracement "gives a sense there's a large enough pool of investors out there who weren't caught off guard .. that maybe we are getting down to levels, where a lot of the pessimism is already priced in."

The Dow Jones Industrial Average (.DJI) rose 575.73 points, or 1.97%, to 29,786.58, the S&P 500 (.SPX) gained 64.6 points, or 1.81%, to 3,641.63 and the Nasdaq Composite (.IXIC) added 158.39 points, or 1.52%, to 10,575.49.

The pan-European STOXX 600 index (.STOXX) rose 0.85% and MSCI's gauge of stocks across the globe (.MIWD00000PUS) gained 1.20%. Emerging market stocks (.MSCIEF) lost 1.10%.

Global markets have suffered a volatile few weeks as investors have worried that major economies will be pushed firmly into recessions before inflation is tamed.

After the data, traders were betting that the Fed would raise interest rates sharply in three weeks' time and ultimately lift rates to 4.75%-5% by early next year.

"After today’s inflation report, there can’t be anyone left in the market who believes the Fed can raise rates by anything less than 75 bps at the November meeting," Seema Shah, Chief Global Strategist at Principal Asset Management said.

"If this kind of upside surprise is repeated next month, we could be facing a fifth consecutive 0.75% hike in December with policy rates blowing through the Fed’s peak rate forecast before this year is over."

Minutes of the Fed's latest policy meeting released on Wednesday showed officials "emphasized the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action." But several policymakers did stress a need to "calibrate" the pace of further rate hikes to reduce the risk of "significant adverse effects" on the economy.

While U.S. Treasury yields shot higher after the hotter-than-expected inflation suggested higher interest rates higher for longer, bond selling eased as the session wore on.

Benchmark 10-year yields were up 5.4 basis points to 3.956%, from 3.902% late on Wednesday.

In currencies the dollar had hit a fresh 24-year peak against the yen and gained across the board, after after the inflation data but the greenback since gave up some gains.

The U.S. currency hit a high of 147.2 yen and pushed the euro to a 2-week low.

Recently though the euro up 0.74% to $0.9776. The Japanese yen weakened 0.18% versus the greenback at 147.16 per dollar, while Sterling was last trading at $1.134, up 2.13% on the day.

Benchmark 10-year gilt yields , which erupted after the UK government laid out tax cutting plans last month, had swung from a fresh 14-year peak at 4.632% to 4.25% in post CPI trading.

The Bank of England has insisted that its emergency bond market support will expire on Friday as originally announced, countering media reports of continued aid if necessary.

While crude oil was having a volatile session the commodity was most recently rallying as low levels of diesel inventory ahead of winter helped investors shrug off higher-than-expected stocks of crude and gasoline. Oil futures had fallen 2% on Wednesday due to demand worries.

U.S. crude recently rose 1.82% to $88.86 per barrel and Brent was at $94.11, up 1.8% on the day. (Reuters)