Markets fall on fears of end to 'easy money' in U.S. , China

Financial markets around the world continued their dive Monday because of investors' anxiety over signals from the U.S.and China that they would start closing the tap of so-called easy money that many of the world's economies havecome to rely on.

All of the major stock market indexes were down at the end of trading Monday. The Dow Jones industrial average fell as much as 248 points in the first hour of trading beforerecovering some of the loss, but still finished down 139.84 points, or 0.9 per cent, at 14,659.56.

The Nasdaq dropped 36.49 points, or 1.1 per cent, to 3,320.76. The S&P 500 index fell 19.34 points, or 1.2 per cent, to 1,573.09, with bank and financial stocks taking the biggest hit, at 1.8 per cent. Bank of America fell the most among major bank stocks, giving up 39 cents, or 3.1 per cent, to $12.30.

For every seven stocks on the New York Stock Exchange thatfell Monday, only one rose.

Similar losses were seen on markets around the world: France's benchmark stock index fell 1.7 per cent; Germany's 1.2 per cent; andBritain's FTSE 100 fell 1.42 per cent.

In Canada, the S&P/TSX composite indexfell 158.80 points, or 1.32 per cent,to 11,836.86, with all 13 subgroups in the indexdeclining, led by metals and mining at 663.39 points.

Thelooniealso tooka hit, losing0.27 of a cent andtrading at 95.37 centsUS by the end of day, having recovered from a low of94.75 cents, its lowest level since 2011.

Commodities were also affected by the slump. Gold fell $14.90, or 1.2 per cent, to $1,277.10. Other metals were down, too. Crude oil rose $1.49, or 1.6 per cent, to $95.18 per barrel.

China's credit-tightening makes investors nervous

The global market sell-off began overnight witha plunge in China caused by a spike in lending rates prompted bythe government's crackdown on off-balance-sheet lending, as a way to curb credit growth.

The Shanghai composite index fellfive per cent Monday, its biggest decline in four years, while the smaller Shenzhen composite index plunged 6.1 per cent to 881.87.

Many analysts seeChina's credit-tightening measures as necessary if the country is to avoid the kind of banking and housingcrises experienced by Europe and some of its Asian neighbours.

"They want to avoid if possible some of the blow-ups they've seen recently around the world," said Ian Nakamoto, director of research at the Toronto investment firm MacDougall, MacDougall, & MacTier. "I think the Chinese are trying as best as possible to have an economic slowdown without a real estate crash."

Stimulus ending sooner ratherthan later

Monday's market plunge was alsoa continuedreaction to U.S. Federal Reserve chairman Ben Bernanke'sannouncementlast Wednesdaythat the Fed could start winding down its economic stimulus program in the next few months and phase it out completelyby mid-2014. The S&P plunged 3.9 per cent on that news between Wednesday and Thursday.

'What caught the market off-guard last week was that[Bernanke] was fairly adamant that the end of what was called easy money is going to be coming sooner rather than later.' Ian Nakamoto, MacDougall, MacDougall, & MacTier

"I think what caught the market off-guard last week was that he was fairly adamant that the end of what was called easy money is going to be coming sooner rather than later," said Nakamoto.

The U.S. central bank has been financing government debt and mortgages for several years by buying $45 billion in U.S. treasury bonds and $40 billion in mortgage-backed securities each month. It has made trillions of dollars worth of bond purchases since 2009 in its effort to keep interest rates low and toencourage borrowing and job growth.

Bernanke said last week that if the unemployment rate continued to improve and the U.S. economy continued to grow, the bond-buying program would end and interest rates would rise from the low levels at which they've been for years.

While such a move had been expected, it wasn't expected to happen so soon, and the accelerated timelineprompted awidespread sell-off in the bond markets, which pushed yields to their highest level in almost two years. The yield on the benchmark 10-year U.S. treasurynoterose to 2.67 per cent at one point Monday and settled at 2.55 per cent, an increase ofmore than100 basis pointsfrom the 2013 low of 1.63 per cent on May 3.

"That's a big move in a very short period of time," Nakamoto said. "I think a lot of it has to do with certain financial institutions were caught offside thinking rates are going to be down here for a long period of time and are unwinding some of their trades."

Bondsell-off extends globally

Bond yields move in the opposite directionto price. An anticipated increase ininterest rates prompts a bond sell-off because bonds issued under the new ratewill have a higher yield, making existing bonds less valuable, andbecause investors arelooking to unload assets and free up cash in anticipation of the rising cost of borrowing and higher future returns. That depresses the amount that people are willing to pay for current bonds but increases the yield of those bonds for those who buy them.

Bond sell-offstook placenot just in the U.S. but also in European and other bond markets as foreign investors anticipated the impact of a U.S. stimulus withdrawal and looked to unwind some of the "hot money" (which gravitates toward high interest rates)that has been pumped intolocal-currency government debt in recent years, especially in emerging markets.

Spain's 10-year bond yield, for example,was abovefive per cent for the first time in three months.

"It's a very connected market," Nakamoto said. "People play different markets. They may borrow in theU.S. and invest inJapan, andvice versa."

Nakamoto and many other analysts feel the bond sell-off is premature andan over-reaction to the Fed's statement.Bond yields reflect where investors think interests rates will go, and right now, they're anticipating they'll rise a lot fasterthan economists hadbeen predicting,which was arise closerto about2.5 per cent by the end of the year and to three per cent in 2014, Nakamoto said.

"I don't think the fundamentals of the economy are that much differentthan, let's say, back in April. I think rates should be higher, but not by this amount," he said.

Sell-off could affect housing market

What worries Nakamoto and others is how fast bond rates have risen.

"Equity markets can handle higher interest rates; what they can't handle is the speed at which it went up," Nakamoto said.

If rates continue to rise, the housing market could start to be affected, although not everybody agrees on how that effect would play out

"Some people say this may prompt people to buy houses sooner rather than later.But on the other hand, peoplesay it could bea bit of sticker shock wherethey may back off."

The key point to remember, Nakamoto said,is that as volatile as markets are now, the central bank still has its hand on the tiller. Bernanke said as much when he stressed that the stimuluspull-backwould proceed only if the economicindicators warranted it.

Nakamoto says that many of the people taking their money out of bonds today are choosing to put it into cash rather than the equity markets but predicts that as markets stabilize that money will flow back into the market.

"I do think as confidence starts to rebuild, as interest rates start to peak, the money will come back into the equity markets not only from the equities that sold off recently but also from bond investors that sold bonds and put it into cash," he said.