US and European stock markets tumbled and government bonds surged on Tuesday as further evidence of economic slowdown emerged on both sides of the Atlantic.
The chief surprise of the day came from the US Institute for Supply Management's non-manufacturing business activity index, which fell to 41.9 per cent in January from 54.4 per cent, the biggest ever monthly decline and its lowest level since October 2001.
It was the first time the index has come in below the 50 level, signifying contraction, since March 2003. "The survey results were downright disastrous," said Stephen Stanley, chief US economist at RBS Greenwich Capital. "These are recessionary readings."
As Wall Street accelerated losses in afternoon trade, credit spreads widened sharply, maintaining support for government bonds. The dollar remained firmer as oil and gold lost ground.
"Stocks were crushed by the ISM weakness, and credit markets also performed poorly," said Ted Wieseman, economist at Morgan Stanley.
Lena Komileva, G7 economist at Tullett Prebon, said the report reinforced the notion that the Federal Reserve had been unable to forestall a recession in spite of aggressive, timely policy easing.
"Fed rate cuts are not the answer to this credit crunch and hence cannot prevent the loss of confidence in the real economy," she said.
Some analysts warned that the ISM report was well out of line with other January indicators. "The ISM indices have only deteriorated this rapidly following a massive shock, such as the 9/11 attacks," said Julian Jessop, at Capital Economics.
"But it may well be significant that after such sharp falls in the past they have typically rebounded in the following month."
US interest rate futures moved to fully price in another half-point cut in US interest rates when the Fed next meets, on March 18.
"We think that the Fed will ease by 50 basis points in March and in April and by another 25bp in June," reducing the Fed funds rate to 1.75 per cent by mid-year said Mr Stanley.
Disappointing services sector and retail sales data in the eurozone prompted similar slowdown fears and raised speculation that the European Central Bank would be forced to soften its hawkish stance on interest rates.
The purchasing managers' services index fell from 52.0 in December to 50.6 in January for the whole of the zone, and dipped below the break-even 50 level in Germany, Italy and Spain. Eurozone retail sales fell 0.1 per cent in December, and were down 2 per cent year on year.
"The sharp deceleration in eurozone services growth coupled with the lacklustre retail sales data suggest market expectations of ECB rate cuts later this year may be more than just wishful thinking," said Martin van Vliet, economist at ING.
The UK's service sector held up better last month, with the business activity index edging up to 52.5 from 52.4.
Analysts said the figures helped reinforce the view that the Bank of England would cut interest rates by 25 basis points to 5.25 per cent tomorrow, rather than by a more aggressive 50bp.
The equity market response to the day's economic news was unequivocal and stocks in New York closed at their lows of the day. Financials led the selling and late in the day Fitch Ratings placed some bond insurers on ratings watch negative.
The S&P 500 fell 3.2 per cent, its worst day in nearly a year and it is down 9 per cent in 2008, its poorest start to a year ever.
The pan-European FTSE Eurofirst 300 index tumbled 3.1 per cent and the FTSE 100 in London shed 2.6 per cent.
Asian markets had staged a broad retreat as investors took profits after the previous session's strong gains and closed positions ahead of the Lunar New Year holiday.
In Tokyo, the Nikkei 225 Average fell 0.8 per cent while Hong Kong lost 0.9 per cent. Australian stocks shed 1.3 per cent as retailers were hit by a 25bp rise in domestic interest rates.
European and US credit spreads widened sharply as stock markets declined. The Markit iTraxx Crossover index, a closely-watched barometer of risk appetite in Europe, widened to 504bp from 471bp late on Monday. The Markit CDX index which references US investment-grade bond risk widened to 117bp from 109bp.
The flight out of equities prompted strong safe-haven buying of government bonds. The yield on the 10-year US Treasury was down 8bp at 3.56 per cent while the two-year yield was 14bp lower at 1.92 per cent.
The Treasury yield curve steepened, with the difference between two-, and 10-year note yields moving to 1.64bp. The curve had steepened from just under 100bp since the start of the year as rate cuts and the prospect of more to come has pulled short-dated yields sharply lower.
"There were good further front-end led gains in late trading as stocks continued hitting new lows that steepened the curve significantly further," said Mr Wieseman.
In Europe, the two-year Schatz yield fell 13bp to 3.26 per cent.
On currency markets, the eurozone data weighed on the euro, sending the single currency down 1.2 per cent against the dollar and 1.1 per cent against the yen.
In commodities, March West Texas Intermediate fell $1.61 to $88.41 a barrel, as the day's economic figures sparked fresh concerns about the impact on demand of a global economic slowdown. Gold consolidated below $900 an ounce.
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