Much of the recovery in global stock markets over the past few years has had its roots on the extra liquidity that's flown through financial markets as a number of central banks, particularly the Fed, have pursued stimulus programs.
"The mood has switched from greedy to fearful," said Chris Beauchamp, market analyst at IG.
In Europe, the FTSE 100 index of leading British shares, which was only around 70 points off its highest-ever close on Wednesday, was down 2.1 percent at 6,700. Germany's DAX, which has hit a series of all-time highs recently, tumbled 2.8 percent to 8,293 while the CAC-40 in France was 2.4 percent lower at 3,955.
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U.S. stocks, which fell sharply Wednesday, were poised for more declines at the open. Dow futures were 1 percent lower while the broader S&P 500 futures fell 1.2 percent. (See pre-market trading action.)
Those declines though are dwarfed by the scale of the reverse in Japan's Nikkei. Some sort of decline in global indexes had been anticipated following a run that's seen many post historic highs.
The Nikkei has been the best-performing major index this year, having risen around 45 percent—before Thursday's loss—to five-year highs. The Nikkei has been buoyed by the announcement of an aggressive monetary stimulus from the Bank of Japan, which has piled the pressure on the yen. That development is a potential boon to the country's exporters and therefore to growth.
Many in the markets blamed the Nikkei's fall on the spike in the interest rate charged on country's benchmark 10-year bond to above 1 percent for the first time in a year. That unnerved investors at a time when Japan's already overburdened government finances are vulnerable to rises in interest rates. The interest rate, or yield, later slipped back to about 0.9 percent.
The sell-off is a reminder of Japan's vulnerability as Prime Minister Shinzo Abe tries to end two decades of stagnation with unprecedented monetary easing, increased government spending and reforms to make the world's No. 3 economy more competitive.
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The level of Japan's debt is higher, relative to its economy, than even some of the crisis-stricken European countries. But because it is mostly owned by domestic investors, especially huge banks and insurance companies, the country's credit rating has remained steady. About a quarter of the national budget is interest payments on government debt.
Markets elsewhere in Asia sank sharply after a survey showed China's manufacturing contracted in May. HSBC said its preliminary Purchasing Managers Index fell to a seven-month low of 49.6 in May from April's 50.4. Numbers below 50 indicate that activity is contracting. Analysts had expected a more modest decline to 50.3.
The Shanghai Composite Index lost 1.2 percent to 2275.67, its biggest fall in a month while the smaller Shenzhen Composite Index shed 0.7 percent to close at 1014.47.
Elsewhere, Hong Kong's Hang Seng slumped 2.5 percent to 22,669.68. South Korea's Kospi lost 1.2 percent to 1,969.19. Australia's S&P/ASX 200 dropped 2 percent to 5,062.40.
There were big moves across a range of financial assets. In the currency markets, the yen was the main mover following the rise in Japanese yields. The yen has bounced back strongly, after falling to near five-year lows against the dollar on Wednesday. The dollar was trading 1.7 percent lower at 101.39 yen, having earlier fallen to a low of 100.86 yen.
Oil prices were under the kosh too amid concerns over the global growth environment—the benchmark New York rate was down $1.19 at $93.09 a barrel. Gold, however, was in demand as it benefited from its status as a haven at a time of uncertainty. It was up 1.3 percent at $1,385 an ounce.
The main debate now in the markets is whether Thursday's developments mark the end of the euphoria that has gripped many investors this year.
"The fact that the equity markets fell so hard on these headlines overnight indicates that perhaps investors have been guilty of too much exuberance in recent months," said Jane Foley, an analyst at Rabobank International.