A wave of selling washed across the financial world Thursday, driving the stock market down, interest rates up, and bringing new tremors of concern that the forces that have been propping up growth are starting to fade away.
The U.S. stock market closed Thursday down 2.5 percent following a 1.4 percent drop on Wednesday, but those moderate declines don't capture the sense of fear that captured trading floors from Wall Street to London to Tokyo this week. The very underpinnings of a four-year bull market seemed to be coming unglued. An index of expected future market volatility soared 23 percent, to its highest level since the fiscal cliff standoff at the end of last year.
Markets are spooked, interest rates are on the rise across the globe, and a manufacturing survey hinted at new economic weakness in China. If those trends continue it could be enough to take the air out of a U.S. economic recovery that was just gaining momentum.
This isn't a crisis like the ones that struck the United States starting in 2008 or Europe in 2010. Rather, it is a byproduct of the world's central banks, having intervened on vast scale to deal with the economic travails of the last several years, introducing uncertainty and even a little chaos as they start to contemplate how and when the era of easy money might end.
Over the last five years, the Federal Reserve has injected more than $2.7 trillion in newly created dollars into the financial system and is continuing to add to that total to the tune of $85 billion a month. But in a news conference Wednesday, chairman Ben S. Bernanke made clear that the central bank expects to start pulling back the throttle later this year and ending the purchases entirely, if the economy cooperates, next summer.
That was enough to spark a sell-off on bond markets, which drove the interest rate the U.S. government must pay to borrow money to rise to its highest level since October 2011. Those higher rates will soon translate to higher home mortgage rates for ordinary Americans, putting one of the support struts of the economy, the housing rebound, at risk. Home builders' stocks fell particularly steeply on Thursday.
"The higher rates mean that businesses will also need to pay more for financing their investments," said Jason Benowitz of Roosevelt Investment Group in New York. "A dramatic rise of interest rates could indeed hit growth."
The Fed's actions -- and now its potential unwinding of those actions -- have had global ramifications, and Bernanke's comments Wednesday triggered a flurry of activity in Asian markets overnight. As traders grappled with the possibility of a world less awash in dollars, borrowing costs skyrocketed across the globe, particularly in emerging markets. For example, the cost for the Indonesian government to borrow money for a decade rose more than half a percentage point, to 4.8 percent; similarly eye-popping interest rate increases occurred in countries including Brazil, Mexico, Turkey, Russia, and Poland.
Indeed, the Chinese central bank had to launch an intervention of its own to combat the rise in price of money; Bloomberg reported that the People's Bank of China injected $8.2 billion into that nation's financial system to combat an abrupt increase in interest rates. A weak report on Chinese manufacturing contributed to a rout in Asian markets.
"I think if it was just the Fed tapering, we wouldn't see such a negative reaction, because after all it was expected," said Sam Stovall, chief equity strategist at S&P Capital IQ. "Add on the concern that China is slowing, as the preliminary PMI figures are showing . . . and that bad news usually come in threes, so the market is expecting some more bad news"
The signs of economic weakness in China contributed to a steep drop in the prices of global commodities as well. Crude oil prices fell 3.4 percent to $95.14 a barrel Thursday, the price of corn fell 1.8 percent, and gold was down just slightly Thursday after a 4.9 percent tumble Wednesday.
The volatility across world markets Wednesday and Thursday had some echoes in what has happened in Japan in recent weeks. That nation, where the Bank of Japan has an aggressive plan to try to end its long period of deflation and stagnant growth, has seen extreme stock market drops of 7.3 percent and 6.4 percent on separate days over the last month. The volatility seems to be a consequence of a world in which prices are being driven by the money-printing, or lack thereof, by central bankers.
One saving grace for the United States: If the market swings really do undermine U.S. growth, then the Fed, as Bernanke said repeatedly in his news conference, will move that much more gingerly in removing its help for the economy. Indeed, just Thursday, investors' expectations for inflation over the next few years fell 0.1 percentage point, to 1.75 percent, the lowest since last July. Because the Fed aims for inflation of 2 percent, that would suggest there is more room for the central bank to pump money into the economy without sparking an outburst of higher prices.
In effect, with the Fed starting to think about an exit from an era of easy money, it will be a great test of just how resilient this economic recovery really is. If the whole thing -- the rises in stock prices, in corporate earnings, in the housing market, even in job growth -- is driven solely by the flood of money, or whether five years of zero-interest rates and trillions of dollars in bond purchases have succeeded at getting a more resilient economic engine for the United States up and running.