News of an unexpected 0.4 per cent drop in US retail sales last month and a record quarterly loss of $9.8bn, marked by an $18.1bn writedown on mortgages and increased credit card loss provisions at Citigroup (NYSE:C), the investment bank, helped undermine Wall Street.
In Europe, a weak survey of German investor sentiment and unexpected subprime-linked writedowns at Hypo Real Estate weighed.
"There is a clear sense out there that the real economy is now facing a major risk," said Ian Harnett, managing director of Absolute Strategy Research. "The question is: how responsive will the central banks be?"
The US bond market rallied to its best levels as stocks slumped to fresh lows late on. The yield on the policy-sensitive two-year Treasury note was trading at2.50 per cent and had reversed a climb towards 2.59 per cent early in the day.
Dominic Konstam, head of interest rate strategy at Credit Suisse, said: "The two-year is pretty reasonably priced, as it is easy to see the Fed cutting rates to at least 3 per cent and even2.5 per cent this year."
Immediately after the slide in retail sales for December, the futures market briefly priced in a 56 per cent chance of a 75bp cut in US rates at the end of the month. That call had waned to around a 40 per cent chance late in the day and limited the two-year note yield's fall.
"Speculation for an inter-meeting ease appears to be waning," said David Ader, bond strategist at RBS Greenwich Capital. "The market continues to price in 50bp of Fed easing by the end of the month."
Combined with relatively benign producer price inflation figures, Tuesday's figures "add weight to theargument for large rate cuts", said James Knightley, at ING.
In Germany, the writedowns at Hypo Real Estate were compounded by another drop in the ZEW institute's economic expectations index, its seventh decline in the past eight months, to a 15-year low.
"German business confidence is in dire straights," said David Brown, European economist at Bear Stearns. "Unless the European Central Bank wakes up pretty soon to easing monetary policy, the eurozone economy could be paying the price with much weaker growth this year."
Equity markets across the globe took a severe beating. In New York, the S&P 500 closed down 2.5 per cent, its lowest close since March.
The Dow Jones Industrial Average fell 2.2 per cent and closed at a nine-month low, while the Nasdaq Composite declined 2.5 per cent, its weakest close since March.
In Europe, the FTSE Eurofirst 300 shed 2.6 per cent and the FTSE 100 in London fell 3.1 per cent.
Asian stocks also fell heavily. In Tokyo, the Nikkei 225 Average fell 1 per cent to close below 14,000 points for the first time in more than two years.
Hong Kong fell 2.4 per cent, Seoul shed 1.1 per cent to a five-month closing low and Sydney lost ground for a seventh successive session.
Government bonds pushed higher after the US data releases and were buoyed by weak stocks. The yield on the 10-year US Treasury was down 9bp at 3.68 per cent while the 10-year Bund yield fell 3bp to 4.02 per cent.
On the currency markets, the dollar tumbled to a 2½-year low against theyen, and edged higher versus the euro.
The Japanese currency rose across the board, notably against the Australian and New Zealand dollars, as investors scaled back risky carry trades, where the yen is sold to fund purchases of higher-yielding assets.
Sterling pulled away from a record low against the euro after the release of UK inflation figures.
In commodities, oil fell back amid concerns that slowing US growth could hit demand. February West Texas Intermediate fell $2.30 a barrel to $91.30. Gold held above $900 an ounce after setting a record high of $914 on Tuesday.
The Baltic Dry Index, a gauge of freight cost for bulk commodities such as iron ore, coal or grain, dropped a further 4.15 per cent to 7,336, taking its fall over the past three days to 12.45 per cent.
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