Worries about the global economy rippled through financial markets on Tuesday, driving down share prices from Tokyo to New York and placing new strains on Spanish and Italian bonds.
Concerns that have been building for days erupted into a selloff that began in Asia, gathered steam in Europe and culminated in a sharp, late-day drop in New York. As the dust settled from the acrimonious debate in Washington over the debt ceiling, investors turned their attention to mounting evidence that the global economy is weakening. Data in recent weeks has shown that the economic "soft-patch" seen around the world in the second quarter is proving deeper and more entrenched than many investors had thought would be the case.
Worries about the economy pushed the Dow down 265-points , it's eighth consecutive decline and longest losing streak in nearly three years. Meanwhile, bond prices soared and yields tumbled. Paul Vigna, Jonathan Cheng and Kelly Evans discuss.
"As people take their focus off the debt ceiling…they're focusing on an economy that looks worse than they had thought," said Erik Weisman, a portfolio manager at MFS Investment Management.
U.S. stocks fell for the eighth straight day, the longest stretch of declines since the 2008 financial crisis. Several measures fell into negative territory for 2011. The Dow Jones Industrial Average dropped below 12000, plunging 265.87 points, or 2.2%, to 11866.62. In its eight-day decline, the blue-chip index is down 6.7%. In Europe, Italian and Spanish bond markets continued their decline, sending yields to euro-era highs. European bank stocks, too, also suffered sharp losses and broader stock indexes tumbled.
Investors sought safe havens, driving yields on U.S. Treasurys and German Bunds to their lowest levels since November. U.K. 10-year bonds hit their lowest yields in history. Gold prices hit a fresh record high at $1,641.90 per ounce, up $22.90.
The concern among investors is that with the U.S. and Europe hamstrung by heavy government and consumer borrowing, slowing economies will make it that much harder to whittle down those debt levels. A string of weak economic reports, including an unexpected decline in July consumer spending posted Tuesday, has investors rethinking expectations for a strong second-half rebound. Investors are bracing for a poor July employment report on Friday.
While the resolution of the debt-ceiling crisis soothed investors' worst fears of a U.S. default, it left hanging over the market the prospects of a credit downgrade. Moody's Investors Service said late Tuesday it would keep the U.S. at its top triple-A rating, but with a negative outlook. Among the potential triggers for a downgrade are weaker-than-expected economic growth, Moody's said. Fitch Ratings and Standard & Poor's are also reviewing their top ratings for U.S. debt.
In Europe, there has been a steady erosion of the relief seen just two weeks ago when officials there unveiled a new bailout plan for Greece. That plan was supposed to shore up confidence that Italy and Spain would be walled off from damaging contagion of the euro zone's debt crisis. But with each passing day, skepticism has mounted that the deal didn't go nearly far enough.
"The whole point…in July was to put an end to the rot," said Gabriel Stein, director at Lombard Street Research in London. "And they didn't."
MFS's Mr. Weisman echoed the sentiment: "It increasingly looks like they're going to have to do a much, much larger package."
The selloff in the Italian bond market took yields to 6.1%, a gap of 3.7 percentage points above 10-year German debt, the widest since the start of the crisis. Spanish 10-year bond yields hit 6.2%, 3.8 percentage points higher than German Bunds.
Higher rates in Italy and Spain, if sustained, hold the potential to cause serious disruption. Both countries are running wide budget deficits, and they need consistent access to fresh financing to cover those gaps and to repay maturing loans.
In Italy, the government shifted into emergency mode Tuesday as government-bond yields climbed and the share prices of the Italian banks that hold them slid precipitously. Prime Minister Silvio Berlusconi is planning to address Parliament on the economy Wednesday amid calls for more budget cuts, and his economy minister, Giulio Tremonti, will be dispatched to Luxembourg for talks with Jean-Claude Juncker, the head of the group of 17 nations that use the euro.
Spanish Prime Minister José Luis Rodriguez Zapatero Tuesday delayed his planned vacation to southern Spain "to more closely follow" the country's "economic indicators," his office said. He later decided to go.
Among the concerns plaguing the European bond market is the heft of the euro zone's bailout fund: Even with promised changes that will increase its lending capacity, it is far from sufficient to provide support to Italy. And the changes—which would give it more firepower to help Spain—haven't actually materialized.
Analysts are also concerned that Italy could see its access to funding strained in September when the country is scheduled to auction €61.7 billion ($87.6 billion) in sovereign bonds, more than double the amount of bonds Italy usually auctions in a month—though still only a small fraction of Italy's more than €1.8 trillion in debt.
A joke making the rounds in the markets is that European officials had done just enough with the July bailout to get through August vacations. "I fear that once everyone is back from holiday things will blow up again," said Lombard Street's Mr. Stein.
In the U.S., euro zone jitters added to worries about the U.S. economy's recent swoon. Unlike last summer, when the Federal Reserve was able to soothe worries about a double-dip into recession with a second round of quantitative easing, the central bank's ability to prop up the U.S. economy and financial markets is seen as limited this time around.
In addition, investors are worried about collateral damage to the already fragile economy from the acrimonious debate in Washington over raising the debt ceiling, said Jeremy Zirin, chief U.S. equity strategist at UBS. That is being reflected in more cautious outlooks from companies when it comes to corporate earnings for coming quarters, he said.
As a result, stocks have tanked despite strong second-quarter earnings.
The Dow remains up 2.5% so far in 2011, but Tuesday's rout took the broader Standard & Poor's 500-Stock Index into the red for the year. The S&P 500 lost 32.89 points, or 2.56% to 1254.05. That left it down 0.29% in 2011.
Amid the worries, investors around world flocked to investments perceived as safer. The yield on the U.S. Treasury 10-year note fell to 2.62%, its lowest level since November. German 10-year bonds saw the yield fall to 2.4%, also a nine-month low. In the U.K., the yield on the 10-year gilt fell to a record low of 2.77%.
The 30-year Treasury yield dropped below 4% for the first time since late last year, and the two-year note yield fell to a record low.
Meanwhile, the strains in short-term money markets eased on Tuesday as lawmakers passed the bill enabling the debt ceiling to be increased, and to avoid the government defaulting on its debts.
Rates on Treasury bills—which move in the opposite direction of prices—had shot higher as worries about a possible default grew last week. In the Fed Funds market, where banks and financial institutions get day-to-day funding, rates were at 0.16% on Tuesday, according to Wrightson ICAP LLC, a money-market brokerage, after popping up to 0.18% Monday from near zero just a few days earlier.
But most short-term rates dropped Tuesday. In the repurchase or "repo" markets, where brokers, banks, hedge funds and institutional investors borrow and lend cash and securities for short periods every day, rates for borrowing overnight using Treasurys as collateral were around 0.25% Tuesday.
That is lower than their peak of as high as 0.40% Monday, but still higher than a couple of weeks ago, when rates were near zero.
—Matt Phillips and Jonathan Cheng contributed to this article.
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