The futures market implied traders saw a 73 per cent chance of the Fed raising rates at its Dec 12-13 meeting, up from 52 per cent before the Fed's latest policy statement and forecast, CME Group's FedWatch tool showed.
World stocks hit another record high on Monday and the dollar reached an eight-week peak against the yen on expectations the U.S. Federal Reserve will unveil plans this week to trim its bloated balance sheet.
Investors also heaved a sigh of relief as the Bank of Japan kept its monetary policy steady and maintained its upbeat view of the economy, saying that exports have been on an increasing trend.
The U.S. central bank also said it would start to reduce its $4.2 trillion worth of bond holdings that ballooned through three rounds of quantitative easing.
"It doesn't get any more brazenly hawkish from Dr Yellen, who along with the majority of her colleagues are clearly in the December rate hike camp and the markets are reacting to this news", said Stephen Innes, head of Asia-Pacific trading at OANDA.
US 10-year Treasury yields, which edged up on Tuesday, retreated slightly.
In Europe, France's CAC 40 was up 0.1 percent at 5,234 while Germany's DAX was 0.1 percent lower at 5,234.
After concluding a closely watched two-day meeting, policy makers announced that they were keeping interest rates on hold but hinted that an increase could be on the cards before the end of the year. The trade-weighted index was at 76.75 from 75.97 yesterday.
"If they trim the balance sheet it will be at a very slow pace not to disrupt asset prices", Ng said.
In energy markets, oil prices retreated from near-five-month highs ahead of this week's meeting between key oil producers on the outlook for further supply cuts.
Gains in recent months for the Canadian dollar be can be partially attributed to the two interest rate hikes this year from the Bank of Canada.
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Prime Minister Shinzo Abe is considering calling a poll for as early as next month to take advantage of his improved approval ratings and disarray in the main opposition party, according to government and ruling party sources.
In currencies, the dollar gained as much as 0.5 percent against the yen to hit 111.42, its highest since late July. Hong Kong's Hang Seng fell nearly 0.4 percent to 28,051.41, while the Shanghai Composite dipped 0.2 percent to 3,356.84.
Talk of monetary tightening and a bounce in the dollar put gold on the defensive.
Spot gold may drop to $1,309 per ounce, as it has broken a support at $1,321, said Reuters technical analyst Wang Tao.
U.S. crude futures CLc1 rose 2 cents to settle at $49.91, while Brent crude futures LCOc1 fell 14 cents to $55.48.
U.S. crude oil prices slipped below $50 per barrel but stayed close to multi-month highs as refineries in Texas continued to restart after Hurricane Harvey.