Stocks finished sharply lower in volatile trading Tuesday after briefly wiping out most of their losses, with all key S&P sectors closing in the red, as the Bank of Japan's latest monetary policy decision disappointed investors.
"Everything's driven by interest rates—there's been a lot of back and forth today as a result," said Brian Battle, vice president of trading at Performance Trust Capital Partners.
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The Dow Jones Industrial Average dropped 116.57 points, or 0.76 percent, to finish at 15,122.02, dragged by American Express and Merck. The blue-chip index swung in a wide range, falling more than 150 points near the open, recovering all of its losses in midday and dropping back near lows in the final hour to close down by more than 100 points.
The S&P 500 slumped 16.68 points, or 1.02 percent, to end at 1,626.13. And the Nasdaq declined 36.82 points, or 1.06 percent, to close at 3,436.95. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, spiked above 17.
All key S&P sectors closed lower, led by banks and energy.
"We started the day knowing that the global markets were disappointed in Japan. But it feels that in the short run, we have a market that perhaps overreacted to the global emerging market selloff and is finding some people on the sidelines that want to put money into work," said Art Hogan, managing director at Lazard Capital Markets.
The Bank of Japan kept kept interest rates and its asset-buying program unchanged, and refrained from introducing new measures to ease market volatility, citing signs of economic recovery. The Japanese Nikkei dropped more than 1 percent, while European markets were also in the red. And the yen rose more than 2 percent to near 97 against the U.S. dollar following the announcement.
Stock markets in Thailand, the Philippines, Indonesia and other Asian markets tumbled to lows last seen in April.
"The BOJ is sending the message that at the end of the day it's a central bank and will not pander to the markets too much," said Vishnu Varathan, market economist at Mizuho Corporate Bank.
Meanwhile, European Central Bank President Mario Draghi said that the central bank will not resort to "higher inflation rates" to resolve the euro zone debt crisis, and will only "intervene" in the bond markets in certain circumstances. His comments come as Germany's constitutional court began a two-day hearing on the legality of the ECB's bond-buying program, which has played a large role in calming financial markets.
On Monday, credit ratings agency Standard & Poor's upgraded its outlook for the U.S. to "stable," highlighting the relatively favorable growth outlook. Still, the stock market largely ignored the endorsement, with major averages closing near the flatline in choppy trading amid worries over when the Fed might scale back its stimulus program.
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Earlier, former World Bank President Robert Zoellik told CNBC that the rolling back of the Fed's asset purchasing program could prove a major issue for countries across the globe.
"[Fed] tapering is a big issue I think for all economies—the U.S., Europe, China, Southeast Asia—the fundamentals still go back to structural reforms," Zoellick said.
Lululemon Athletica plunged more than 15 percent after the yoga apparel maker said its CEO Christine Day will step down. Last week, the company announced that it was starting to get some of its Luon yoga pants back on stock shelves after they were recalled in March for being too sheer.
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Apple ended slightly lower a day after the tech giant unveiled a music streaming service called iTunes Radio and new mobile software at its annual developers' conference.
Meanwhile, Sony and Microsoft released new versions of their videogame consoles at the Electronic Entertainment Expo (E3). Sony edged higher after the Japanese company's PS4 console was priced at $399, undercutting the Xbox One by $100.
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Sprint Nexte rallied after Japan's SoftBank said it was raising its offer for U.S. mobile operator to $21.6 billion. Paulson & Co, Sprint's second biggest investor, said it would vote in favor of SoftBank's improved offer.
On the economic front, wholesale inventories rose 0.2 percent in April, according to the Commerce Department, in line with expectations. Inventories are a key component of gross domestic product changes. Excluding autos, inventories were flat.
Treasury prices weakened after the government auctioned $32 billion in 3-year notes at a high yield of 0.581 percent. The bid-to-cover, an indicator of demand, was 2.95.
—By CNBC's JeeYeon Park. Follow JeeYeon on Twitter:
Coming Up This Week:
WEDNESDAY: MBA mortgage applications, oil inventories, 10-yr note auction, Treasury budget, Capitol Hill summit, Caterpillar shareholder mtg; Earnings from H&R Block, Men's Wearhouse
THURSDAY: Jobless claims, retail sales, import & export prices, business inventories, natural gas inventories, 30-yr bond auction, Fed balance sheet/money supply, Groupon shareholder mtg; Earnings from Casey's General Store
FRIDAY: Producer price index, current account, industrial production, consumer sentiment
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