Global markets fall as end to US stimulus beckons

Market Data

 

Market index	Current value	Trend	Variation	% variation
Dow Jones	14758.32	Down	-353.87	-2.34%
Nasdaq	3364.63	Down	-78.57	-2.28%
S&P 500	1588.19	Down	-40.74	-2.50%
FTSE 100	6159.51	Down	-189.31	-2.98%
Dax	7928.48	Down	-268.60	-3.28%
BBC Global 30	6574.52	Down	-9.68	-0.15%

 

Global markets have fallen sharply after the Federal Reserve signalled it may begin to scale back its stimulus of the US economy later this year. On Wall Street, the Dow Jones dropped 354 points, or 2.3%, to close at 14,758, while the S&P 500 had its worst day since November 2011, shedding 2.5%.

European stock markets were down 3% or more by the close.Other risky investments, such as bonds and commodities also fell, with short-term cash offering the only safe haven. The dollar rose as markets anticipated US interest rates rising sooner than had been thought, while the yen fell.

The markets were spooked after Fed chairman Ben Bernanke said that if the central bank's forecasts were correct, it could begin slowing down its "quantitative easing" program of asset purchases by the end of 2013, and wind them down completely by the middle of 2014.  The end of the asset purchase program would mark a return to the use of interest rates as the monetary policy weapon of choice.

The Fed has been buying bonds at a rate of $85bn a month, but believes it may be able to scale this back as the US economy recovers and end the program next year. The Fed has kept short-term interest rates in a range between zero and 0.25% since December 2008.

Although they are expected to remain close to zero for at least a couple more years, Mr Bernanke's comments raised market expectations that the short-term cost of borrowing would rise sooner than had previously been thought. Mr. Bernanke emphasised that the program was tied to how well the US economy, and in particular, the US jobs market was doing. However, his comments led to a widespread equity sell-off in the US late on Wednesday, with US markets down 1%.

The rest of the world followed suit on Thursday, with the market slide gaining momentum, with US markets falling further after they reopened. The latest market sell-off continues a steady decline in share prices worldwide over the last month.

The expectation of rising interest rates also infected bond markets, which normally provide a safe haven from falls in the stock market. The 10-year US Treasury bond fell sharply in price on Wednesday, causing its yield - the yearly return earned by investors and the implied cost of borrowing of the US government - to rise from 2.19% to 2.35%. On Thursday morning, the rate crept higher to 2.43%.  As a bond's market price falls, its yield goes up, and vice versa. Yields can increase for a number of reasons. Yields for all bonds in a particular currency will rise if markets think that the central bank in that currency will raise short-term interest rates due to stronger growth or higher inflation. Yields for a particular borrower's bonds will rise if markets think there is a greater risk that the borrower will default.

Borrowing costs also rose in other countries - particularly for debtors deemed by markets to be riskier, including recession-hit southern European countries such as Spain and Italy. Even the yield on super-safe German government bonds edged higher, in part due to the widely perceived unwillingness of the European Central Bank to cut eurozone interest rates.

Investors have also been rattled by events in China, where the country's economy appears to be slowing sharply, and its banking system is experiencing severe stress as the Chinese central bank seeks to rein in what the authorities increasingly see as the excessive and opaque lending of recent years. With the central bank unwilling to make cheap loans easily available, the interest rate at which Chinese banks were willing to lend to each other overnight jumped to an unprecedented annualized 30% on Thursday.

 

Michael Hewson, a senior market analyst at CMC Markets, says he think the reaction to the Fed comments has been "somewhat overblown" There are widespread fears that the state-owned banks may be facing heavy losses on the glut of loans they rushed out over the last five years in order to keep the Chinese economy afloat despite the stagnation of its main Western export markets.

Evidence that both the US and Chinese central banks were taking their foot off the economic accelerator also depressed global commodities market. China is the dominant consumer of many of the world's raw materials, particularly industrial metals, iron ore and other materials used in its construction boom.

The prospect of higher interest rates in US dollars also translated into a stronger US currency.
All major currencies fell against the dollar, as did the price of precious metals. Gold resumed its rout of recent months, dropping another 6% on Thursday. It is now down 28% since the apparent bubble in the metal burst in October. The price of silver - the more volatile of the two - fell 6.4%.

The metals have proved popular among investors who fear that the Fed's money printing would eventually result in sharply rising prices - something that has as yet failed to materialize.