Dow plunges nearly 200 amid interest rise fears

A sharp sell-off on Wall Street gathered pace last night as investors feared that rising interest rates will cut profits and choke off the boom in mergers and acquisitions.

The Dow Jones Industrial Average plunged 198.9 to 13,266.7, meaning it has now lost 3 per cent in three days.

More robust economic data, including an unexpected drop in US unemployment, has shaken investors' confidence that the Federal Reserve has finished raising interest rates. Instead, the bond market has been pointing to higher rates, and one of Wall Street's most respected bond investors predicted yesterday interest rates could go as high as 6.5 per cent by the beginning of the next decade.

Bill Gross, investment manager at Pacific Investment Management, said that, although he expected interest rates could be cut this year, the longer-term outlook is for gradually rising rates and therefore declining bond prices.

"After 25 years of being a bull market manager to all of a sudden become a bear market manager, although mildly so in terms of higher interest rates over the next three to five years, is sort of a major shift," he said. "But I think it is a well-deserved shift."

Interest rates on US government bonds jumped sharply yesterday, with the yield on the closely watched 10-year Treasury rising above 5 per cent to its highest level since last July. An unexpected interest rate hike in New Zealand underscored how a fight against inflation is still top of many central bank agendas.

Economists had thought that, with ailing housebuilders laying off workers in many parts of the US, unemployment figures would show another increase in weekly claimant rate. In fact, it fell from 310,000 the previous week to 309,000, underpinning consumer spending for the time being.

Wholesalers were also adding to the economic confidence yesterday, with data showing that the ratio of inventories to sales equalled a record low in April, setting the stage for an increase in production.

Yesterday's fall by the Dow was the worst since March, when investors were panicked over a potential slump in the US housing market and a dramatic correction in Asia's inflated share prices. The markets later recovered their poise, with both the Dow and the much wider S&P 500 index hitting all-time records this Monday.

This week's sell-off began on Tuesday with comments by Ben Bernanke, the chairman of the Federal Reserve, that the economic outlook continues to be bright, suggesting there is no need to stimulate the economy through a rate cut.