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Stock markets tumble after Operation Twist … and doubt

US Federal Reserve strategy to calm financial markets causes investor fright as markets from London to Asia plunge

The US Federal Reserve’s Operation Twist failed to bring calm to financial markets, which tumbled on Thursday as investors took fright at the US central bank’s gloomy warning about the economic outlook.

The FTSE 100 index in London plunged 174 points in early trading, a 3.3% drop, with not a single riser in sight. In Asia, markets also suffered heavy losses, with the Nikkei closing down 2.1%, Hong Kong’s Hang Seng tumbling 4.3% and Jakarta’s stock market losing over 7%. Brent crude oil lost nearly to 8.59 a barrel.

The sell-off came after the Fed unveiled a new 0bn bond-buying plan on Wednesday to ward off a double-dip recession, as it emerged that the Bank of England was also getting ready to pump more money into the British economy.

The Fed’s open markets committee said the economic outlook had deteriorated sharply, noting there were “significant downside risks” to its economic forecasts and indicating that a full recovery was years away. “Recent indicators point to continuing weakness in overall labour market conditions, and the unemployment rate remains elevated.”

This drove the Dow Jones down 2.5% on Wednesday while the Standard & Poor’s 500 index lost 3%.

Ben Potter of IG Markets in Melbourne, Australia, said he expected “a session of heavy selling as the world reacts to the Fed’s downbeat outlook for the US economy”.

News that Chinese factory output had shrunk for a third month in September as flagging overseas demand put the brakes on new orders also weighed on markets.

“It is another blow after the Fed’s language about downside risks on the economy really hurt sentiment,” David Thurtell of Citigroup in Singapore told Reuters.

Double twist

“Operation Twist”, named after a similar measure launched in the 1960s under President Kennedy, will see the Fed buying 0bn (£258bn) of long-term Treasury bonds by June 2012 and selling shorter-term debts. The measure is aimed at driving down long-term interest rates across the economy, in an attempt to reduce the cost of borrowing for indebted homeowners and struggling firms.

In another effort to help the ailing US housing market, the Fed chairman, Ben Bernanke, said as the mortgage-backed securities it owns matured, it would reinvest the proceeds in buying new mortgage bonds. Economists called the measures a “double twist”.

Gary Jenkins, head of fixed income at Evolution Securities, said: “Twist and doubt? You have to hand it to the Fed. They have gone all retro on us and persuaded the market to call their latest attempt at intervention ‘Operation Twist’ rather than ‘QE 3′. The latter might imply that the first two attempts didn’t quite work out as hoped so far better to change the name …”

He added: “The basic idea is of course to stimulate economic growth by persuading investors into risk assets … the one thing that is clear is that Mr Bernanke is prepared to use all the weapons in his armoury in order to try and ensure that the US does not enter a long period of low growth, so Operation Twist may not be the last intervention unless it works. And of course the UK is about to follow suit.”

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