Markets respond to Bernanke

Violent sell-off in world markets after Federal Reserve signals end to QE

Ben Bernanke's comments spark a global fall in stock markets and commodities, and strong rise in government bond yields

the Guardian,

26 January, 2013

Stock markets worldwide plummeted on Thursday, after the Federal Reserve chairman, Ben Bernanke, rattled investors by signalling an end to America's drastic recession-busting policy of quantitative easing.

Share prices across the globe have surged over the past year, helped by an unprecedented injection of cheap money, with the Fed buying up $85bn (£55bn) worth of bonds every month, and the Bank of Japan pledging "shock and awe" QE to revive a stagnant national economy.

But when Bernanke laid out a timetable on Wednesday night for cutting off the Fed's bond purchases by mid-2014, his words prompted a violent sell-off, which began in New York after European markets were closed, and ricocheted around the world on Thursday, from Tokyo to Istanbul and Oslo to Jakarta. In London, the 2.98% decline in the FTSE 100 index was the steepest since September 2011.

Elsewhere in Europe, shares suffered their biggest one-day fall in 19 months, with Spain's Ibex losing 2.9%, and the German, French and Italian markets all down by more than 3%.

The slide on Wall Street resumed when US markets reopened on Thursday. After heavy selling throughout the day the Dow Jones closed down 2.3%.

"We've had a market that for some years has been addicted to stimulus, and it's taken a brave man to say it has to end somewhere," said Neil Mellor, of BNY Mellon. He added that the true test of whether the US economy was strong enough to cope without QE would come when the prop of cheap money had been removed. "We don't know if there's a credible recovery there; we're peeling back the plaster."

Bond prices also fell worldwide, a trend that will push up borrowing costs for governments and consumers if it is sustained. Andy Haldane, the Bank of England's outspoken director for financial stability, warned last week that through QE, policymakers had deliberately inflated "the biggest bond bubble in history".

He added that a "disorderly reversion in the yields of government bonds globally" was the greatest risk to financial stability. The yield – or interest rate – on British government 10-year bonds jumped to 2.3%, the highest level for more than a year, although it remains low in historical terms.

Growing fears of problems in China's banking sector, as the authorities try to manage the transition from rampant, export-led growth to a more sustainable, consumer-led economic model, also helped stoke investors' alarm. Those concerns sent the price of many commodities – dependent on Chinese demand – deep into the red.

The price of gold plummeted more than 6% on the day, falling through $1,290 an ounce, down 30% from its peak. Investors who feared that QE would unleash a wave of inflation have taken refuge in the safe haven of the precious metal over the past two years. Silver fell even further, down more than 8% on the day.

The cost of a barrel of oil also dropped, by almost $4. Commodity firms were among the biggest fallers on the FTSE, with BHP Billiton down by 4.6%, and mining and trading company Glencore Xstrata down by 4.75%.

Bernanke, who looks likely to leave his job at the end of his term next January, was careful to stress that bond purchases would be halted only if the economy continued to improve. But investors nevertheless took his statement as a strong signal that the days of cheap money are coming to an end.

"The markets are extrapolating," said Russell Jones, of Llewellyn Consulting. "The danger for policymakers is that if it continues, and you get a big interest rate shock through the bond markets, and a big equity market shock, that in itself slows the economy down. There comes a time when this sort of reaction becomes self-defeating. We're not there yet, but if this goes on, it's a risk."

With bond yields rising and currencies falling across scores of emerging markets, there is also a risk that vulnerable countries, heavily dependent on flows of "hot money" from foreign investors, will be plunged into crisis. In Turkey, where a wave of recent protests has highlighted the political risks for investors, shares closed more than 21% lower than their high last month.