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Wall Street Recovers After Worldwide Slump Fed Fears Shake Global Markets but Fade on Wall St.
(about 4 hours later)
Stock prices around the world were volatile on Thursday, with Wall Street hovering between positive and negative territory before finishing down slightly, after global investors were rattled by signs of a slowdown in Chinese manufacturing and a potential easing of central bank support for the economy. Investors are contemplating a future without support from one of the biggest engines of the global economy in recent years: the Federal Reserve.
The worst drop was in Tokyo, where the Nikkei index fell 7.3 percent, the most since the 2011 tsunami there. In New York, the benchmark Standard & Poor’s 500-stock index was down 0.9 percent in morning trading but regained ground during the day before settling at 1,650.51, down 4.84 points, or 0.3 percent. The Dow Jones industrial average fell 12.67 points, or 0.1 percent, to 15,294.50. The Nasdaq composite index fell 3.88 points, or 0.1 percent, to 3,459.42. In Europe, leading indexes closed down 2.1 percent in Germany and France. Fears that the Fed is about to reduce its stimulus helped send stock, bond and currency prices on a wild ride on Wednesday and Thursday, with Japanese stocks experiencing their worst one-day decline since the 2011 tsunami and United States indexes slumping before ending the day down slightly.
The pessimism that overtook global investors on Thursday was a sharp reversal from months of steady advances in share prices around the world. Many investors had voiced concern that the rally was due for a break, but it had not been clear what would serve as a catalyst for a downturn. Japan’s losses were fed in part by disappointing data on the Chinese economy. Around the world, though, traders debated the significance of the statement made on Wednesday before Congress by the Fed’s chairman, Ben S. Bernanke, that a change could come in “the next few meetings” of the central bank’s policy-setting committee.
The dip began on Wednesday afternoon, after the Federal Reserve chairman, Ben S. Bernanke, testified before Congress that the Fed could pull back on its monetary stimulus programs if the economy continued to show progress. Later on, an index of Chinese manufacturing showed that activity actually slowed in May for the first time in months. The sweeping stimulus programs initiated by Mr. Bernanke have helped feed a four-year rally in United States stock prices and inspired other central banks to follow suit. But even fans of the Fed’s efforts have said that the size and scope of the stimulus make it hard to know what will happen once the Fed begins to take its foot off the gas, paving the way for unanticipated consequences and more market volatility.
The Chinese purchasing managers index, released by HSBC, fell to 49.6 points in May from 50.4 a month earlier. A reading below 50 signals a contraction. “There are no neat answers, because we’ve never been in this situation before,” said Marshall Front, co-founder of the money manager Front Barnett Associates, who has been preparing his own firm’s portfolios for the uncertainty.
China’s slowing momentum has been long in the making and has been, to some extent, deliberately engineered by the authorities in Beijing, who are trying to bring about a more balanced pace of growth. Still, disappointments over the performance of China’s economy – the second-largest in the world after that of the United States – remain liable to unsettle markets around the globe. Fed officials are well aware of the confusion that lies in store and have emphasized that any changes are still a ways off and likely to be carried out slowly. The president of the St. Louis Federal Reserve Bank, James Bullard, said in a speech in London on Thursday that even after the central bank begins to slow down monetary stimulus, policy makers could step in again if the economy shows signs of faltering.
The response was particularly stark in Japan, where the government is in the early stages of an aggressive effort to prop up the long-suffering economy. High hopes that the bold economic policies of Prime Minister Shinzo Abe will succeed have prompted a huge rally in stocks since November. The Japanese market is still up nearly 40 percent since the start of the year. The nerves of at least some American investors were calmed by the end of Thursday. After starting the day down more than 1 percent, the Standard & Poor’s 500-stock index recovered to finish the day down 0.3 percent, or 4.84 points, at 1,650.51. The Dow Jones industrial average dropped 0.1 percent, or 12.67 points, to close at 15,294.50. The Nasdaq composite index fell 3.88 points, or 0.1 percent, to 3,459.42. In the market for United States government bonds, the price of the benchmark 10-year Treasury rose 6/32, to 97 20/32, and the yield fell to 2.02 percent from 2.04 late on Wednesday.
Akira Amari, Japan’s economy minister, sought to calm nerves after the market closed on Thursday. “The Japanese economy is staging a sound recovery, and there is no need for panic,” he said, according to the Nikkei business daily. The plunge “is not exceedingly large, and stock prices in China, where the shock originated, have not fallen so much either,” he added. Other stock markets were hit harder. In Tokyo, the benchmark Nikkei index suffered a 7.3 percent rout. Leading indexes were down about 2.1 percent in Germany, France and Britain.
“The stock market’s rise has so far been largely driven by expectations of an economic turnaround, but we’ve yet to see Mr. Abe’s policies really gain traction,” said Kiyoshi Yoshimoto, chief senior economist at the Japan Research Institute in Tokyo. “That means even small shocks, like lower-than-expected numbers out of China or some volatility in bond markets, can trigger a big but temporary response.” Speculation that the Fed will slow its monthly purchases of government bonds has been growing for months. Investors have known that the central bank’s efforts could not continue forever, and many asset managers have begun to prepare their portfolios for the day when the Fed pulls back.
Analysts have broadly welcomed Mr. Abe’s efforts to breathe life into the Japanese economy through a three-pronged approach of major fiscal spending, a promise to pursue structural reforms and a monetary policy that has effectively flooded the economy with cheap money through purchases of government bonds, commercial debt and other assets. Mr. Front’s firm has sold all of its long-term bonds to reduce exposure to any future changes in interest rates, and it no longer holds any Treasury bonds. In a more optimistic vein, the firm has been shifting money into riskier stocks on the assumption that rising interest rates will be accompanied by growing economies around the world.
One result has been a weakening of the yen, whose 17 percent drop against the dollar since the start of this year has helped lift the earnings prospects of many Japanese exporters. Data released in the last few weeks have shown that the economy has begun to pick up speed. Before this week, even many close Fed watchers assumed that any change would not come before the end of the year. But Mr. Bernanke’s comments on Wednesday led many strategists to bump up their forecasts a few months to September.
Taking many market observers by surprise, however, bond yields have risen in recent days, fanning worries about a rising interest rate burden for the government. The yield on the 10-year Japanese government bond briefly spiked above 1 percent on Thursday before dropping back to 0.9 percent. The move spooked investors, helping produce the fall in the stock markets, said Stephen Davies, chief executive of Javelin Wealth Management in Singapore. “This might be closer than we thought,” said John Bellows, a former Treasury Department official who now works at Western Asset.
Japan is vulnerable to rising borrowing costs because of its high public debt, which is twice the size of its economy. Bonds are also the main financial assets held by banks, pension funds and insurance companies, making a surge in debt yields perilous. When the Fed does shift gears, Mr. Bernanke has indicated, the process will be gradual and will begin with a slow tapering of bond purchases. Even that will commence only if the labor market grows stronger and unemployment falls further.
Given the indebtedness of the Japanese government, there are worries about the effect that this could have if sustained, Mr. Davies said. “It is too early to say whether it will be sustained, so we should not read too much into one day’s extreme move in the markets.” The economic data coming out of the United States on Thursday showed slight signs of improvement. The number of people who filed for unemployment benefits last week was 340,000, lower than analysts had expected and lower than the week before. And the number of new homes sold rose more than expected, to the highest level since 2010.
The sell-off on Thursday came in spite of economic news from Europe that was, if not good, at least better than many expected. The Markit Economics euro zone purchasing managers’ index for the manufacturing sector rose to 47.8 points from 46.7, while the services index rose to 47.5 from 47. While that points to continuing contraction, the improvement suggests the economy may be getting nearer to its nadir, setting up conditions for a rebound in the second half. The housing market has been one of the biggest beneficiaries of the Fed’s wide-ranging purchases of government and mortgage-backed bonds. When the Fed slows the purchase of those bonds, other investors may become less eager to buy the bonds, and mortgage rates could rise for prospective homeowners, exerting a new drag on the housing market.
The economic data coming out of the United States on Thursday also looked better than expected. The number of people filing for unemployment benefits last week was 340,000, lower than analysts had expected and lower than the week before. The way that investors respond to the Fed’s changing policy will determine how the economy is affected. That will be hard to predict even for the smart minds at the Fed, said William O’Donnell, the head of Treasury bond strategy at RBS Securities.
Signs of a strengthening economy could amplify the talk about the Fed slowing down its bond-buying program. But Fed officials have been emphatic that they will not pull back unless it is clear the economy can handle it. Some strategists said on Thursday that investors were overstating the risk of a Fed drawdown. “We’ve supported the Fed’s actions for a long time,” Mr. O’Donnell said. “But we’ve long harbored fears that the exit is likely to be messy with lots of unintended consequences.”
James Bullard, president of the Federal Reserve Bank of St. Louis, said in a speech in London on Thursday that the Fed was likely to “continue with the present quantitative easing program.” The harshest critics of the Fed are worried that a change in policy could pop what some believe to be an artificially inflated bubble in stock prices. But even many investors who expect further volatility do not expect any significant reversal in the big market rally of the last few years.

David Jolly contributed reporting from Paris and Hiroko Tabuchi from Tokyo.

Peter C. Andersen, a portfolio manager at Congress Asset Management, has been buying growth-oriented stocks in preparation for another rise in the stock market. He noted that the Fed was likely to let interest rates rise only if the economy was improving, which would in turn help American stocks. Mr. Anderson added that the Fed was giving markets plenty of notice of even small changes in policy.
“They’ve been exceptionally good at communicating their intentions,” Mr. Anderson said.
Whatever the uncertainty in the United States, the picture is even murkier overseas. The Japanese government, which has been trying to follow the Fed’s lead in stimulating its own economy, faced a setback on Thursday in the plummet of the Nikkei.
The drop was a sharp reversal for a stock market that has been one of the world’s best performers this year, thanks to the energizing effect of Prime Minister Shinzo Abe’s economic shock therapy.
There was disagreement about what had caused the dive. The Fed took some of the blame, as did the release of data on China’s manufacturing sector. The China purchasing managers’ index, released by HSBC, fell to 49.6 points in May from 50.4 a month earlier, suggesting a slowdown in the Chinese economy, the world’s largest after the United States. A reading below 50 signals a contraction.
China’s slowing momentum has been, to some extent, deliberately engineered by the authorities in Beijing, who are trying to bring about a more balanced pace of growth. Still, disappointments over the performance of China’s economy — the second largest in the world after that of the United States — remain liable to unsettle markets around the globe.

Bettina Wassener contributed reporting from Hong Kong.