Markets extend slide over Fed concerns, poor economic news from China

The stock market plummeted on Thursday, posting its biggest one-day drop since 2011, rocked by investor concern that the Federal Reserve is getting closer to pulling back on its stimulus program and by poor economic news from China.

The Standard & Poor’s 500 Index tumbled 1,588 points, closing down 2.5 percent, its worst drop since November 2011. The benchmark index’s two-day loss was the biggest since November 2012, at 3.9 percent. The Dow Jones Industrial Average erased nearly 354 points, closing down 2.3 percent.

Equities and demand for government bonds continued to fall a day after the Federal Reserve said that it may begin phasing out its policy of buying $85 billion a month in bonds to grow the economy as early as September. Fed Chairman Ben Bernanke also indicated in a news conference Wednesday that the central bank could decide to end the stimulus program in mid-2014

The interest rate of 10-year U.S. Treasuries rose to a 22-month high of 2.47 percent, the the highest since Aug. 8, 2011, according to Bloomberg Bond Trader prices. The 30-year bond yield rose above 3.5 percent for the first time since September 2011, reaching 3.53 percent.

Also Thursday, preliminary figures pointed to a slowdown in Chinese manufacturing, adding to concerns about weak growth in the world’s second-largest economy.

The dollar rose against the euro and the yen, as market volatility heated up. The U.S. currency rose 0.6 percent to $1.3220 per euro, its biggest gain since May 9, and also advanced 1.6 percent against the yen, to 97.96 per yen.

As the U.S. economic recovery strengthens, the Federal Reserve is beginning to prepare the markets for a less accommodating policy. But though the economic outlook is brightening, investors are anxious about a slowdown in stimulus and are shifting away from government bonds and toward the dollar. Global and domestic markets are in reaction mode.

Some analysts, however, say that investors are reacting more out of fear that interest rates are rising too quickly than that the Fed will begin tapering its assets.

“I think that if it was just the Fed tapering, we wouldn’t see such a negative reaction, because it was expected,” said Sam Stovall, chief equity strategist at S&P Capital IQ. “People are concerned. It’s been decades since interest rates were this low, and for them to rise from 1.4 to 2-2.4 percent in such a short period of time, that’s a big move. It’s not as much about the absolute level of interest rates, but rather about how fast they rise.”

Stovall noted that “what we are seeing is the market factoring in the rise of interest rates.”

Jason Benowitz, of Roosevelt Investment Group Inc. in New York, said that “the Fed tapering means less demand for bonds, but also less liquidity in the markets,” as the bond-buying program has also propped up the stock market.

“The near-term sell-off is a reaction to less liquidity,” Benowitz said, “and the higher rates for longer maturity bonds mean that businesses will also need to pay more for financing. Hence, a dramatic rise of interest rates could hit growth.”

Roosevelt Investment Group estimates that if the Fed stops its bond-buying program, 10-year Treasury yields could rise from their recent low of 1.4 percent to 2.7 percent to 3 percent by the end of year, and even 4 percent in 2014. Still, Benowitz thinks that ”even though some sell-off is to be expected, this shouldn’t turn into a bear market”.

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