Traders and investors around the world began selling stocks and bonds yesterday, sucking money out of global markets after the US Federal Reserve signalled that it could begin rolling back its bond-buying programme later this year and end it altogether around next summer.
The prospect sent investors rushing for the exit at such speed that, in New York, both the S&P 500 and the Dow Jones Industrial Average recorded their worst daily declines since 2011. The Dow fell by 353.87 points, down 2.3 per cent, to 14,758.3, while the S&P 500 dropped by 2.5 per cent to 1,588.19.
Hours earlier, in London, the FTSE 100 sank to its lowest close since mid-January, ending 3 per cent in the red at 6159.51. The index has now seen virtually all its gains for the year wiped out less than a month after it was closing in on its all-time high of 6930. In Europe, Germany's DAX index was down more then 3 per cent, while in Paris, the CAC 40 fared even worse, slumping by 3.7 per cent.
The global market rout came after a 200-point drop in the Dow on Wednesday, which was triggered by comments from the Fed chairman Ben Bernanke that if economic data in the US continued to show signs of improvement, the central bank could begin cutting the size of its stimulus programme later this year.
The programme – under which the Fed buys $85bn worth of mortgage and government bonds every month – could then end altogether around the middle of next year, he said.
In its latest forecasts, meanwhile, the Fed also projected a decline in US unemployment to between 6.5 per cent and 6.8 per cent by the end of 2014, earlier than perviously anticipated. However, the Fed's key interest rate is unlikely to rise any time soon.
While the timeline for the reversal of the bond buying programme could change depending on the economic outlook, Mr Bernanke's comments gave investors the clearest indication yet of the thinking inside the central bank.
That triggered a panic, amid concerns about the outlook for the global economy once the Fed yanks away the crutches. Feeding the fears was overnight data from China that showed a decline in manufacturing output.
On the bond markets, the selling drove up the UK Government's cost of borrowing to its highest level for more than a year as investors exited sovereign debt across the board.
Yields on the Government's benchmark 10-year gilt jumped 18 basis points at one stage to 2.32 per cent, the highest since March 2012 – having already risen from a recent low of 1.6 per cent at the beginning of May.
One dealer said gilt trades had hit double their usual volume on a frenetic day of selling: "The moves in the market are akin to what you would expect if there was a surprise interest rate hike."
Rising gilt yields are usually associated with recovery as the prospect of interest rate rises draws nearer. But the turmoil underlines the risks involved in exiting five years of exceptional monetary stimulus by central banks around the world.
The poor news from China, where faltering demand depressed factory output in June to a nine-month low, also combined with a stronger dollar to drag oil prices lower.
Gold, which has been fuelled by money printing and rock-bottom interest rates, sank nearly 5 per cent to $1,285.90 at one stage – the weakest in nearly three years.