Ebola worries fan flight-to-safety trade

Concerns the U.S. government and health professionals have not dealt quickly or carefully enough with Ebola sent investors into bonds and added to the pressure on a stock market already slammed by global growth concerns.

A second Dallas health-care worker was diagnosed with Ebola, and the Centers for Disease Control revealed Wednesday that the worker traveled on a Frontier Airlines plane the day before the diagnosis.

"Obama has canceled a trip, and the CDC is making a statement. That has made people anxious. Confidence in Washington right now is not good. When it's a health-care issue, it affects all of us," said Ward McCarthy, chief financial economist at Jefferies.

"They should have gotten out in front of it, and now it looks like they're falling behind. That's having a negative effect on the way the stock market is trading and positive effect on the bond market."

A trio of weak data, showing a pullback in consumer spending, softer manufacturing and falling inflation, fueled selling in stocks early Wednesday on fears that the U.S. economy cannot hold the line against a global slowdown. Economists immediately slashed their U.S. GDP growth forecasts for the third quarter. Barclays and Credit Suisse said tracking GDP growth fell to 3 percent from 3.3 percent.

The Dow Jones industrial average plunged more than 350 points minutes after opening, then recovered more than half its losses before moving lower again with a more than 400 point decline in afternoon trading. The Dow was well off its lows heading into the market close. The S&P 500 index and the Nasdaq were also whipsawed, but the Russell 2000 headed into positive territory in the final hour.

Before the opening bell, the September retail sales report showed the first decline in eight months. Sales were down 0.3 percent, in large part due to fewer vehicle purchases and a decline in gasoline. Inflation data also disappointed with the producer price index for final demand decreasing 0.1 percent, versus expectations for a 0.1 percent increase.

Read MoreThetop 10 signs for when the selling is over

The economic reports also confirmed some traders' views that the Fed will not move to hike interest rates in the middle of next year, as expected by many Wall Street economists. The 10-year Treasury yield fell below 2.0 percent in a slide that paralleled a slump in German bund yields.

"When people see a 10-year yield at 1.96, they freak out," said Peter Boockvar at Lindsey Group. "This is a panic. It's a panic out of stocks. It's a panic into Treasurys. Gold is higher. The dollar is getting hammered. There's a lot of cross currents here."

As Boockvar spoke in a phone interview before the market recovered its worst losses, the 10-year yield continued to slide to 1.86. The yield returned to 2 percent and fluctuated in midday trading.

"The bond market is doing what it does best. It's speculating on a future which may not happen. We got the double whammy today. We got some deflation fear. We got the consumers not only slowing purchases but they actually cut their purchases," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi.

The market had already been wavering on worries about Europe, where German bund yields fell to record lows. Greece was a source of concern, as its market plunged on concerns Athens will seek to exit the government bailout and try to go it alone.

"I think immediately you have to cut back (U.S. GDP growth expectations) a half percentage point to 2.5 based on retail sales," Rupkey said. "The consumer looks pretty dead in the water here. If it does reach 3.0 it's going to be due to the fact that goods are stacking up on store shelves due to an inventory overhang."

Read MoreWeak producer prices, factories slow down

Traders on the floor of the New York Stock Exchange.
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Traders on the floor of the New York Stock Exchange.

As traders sought safety in bonds, they were also placing bets that the Federal Reserve would not hike interest rates until later next year because of a softer economy.

"The bottom line is the omnipotence of central banks is losing its luster," Boockvar said. "The yield of the December 2015 fed funds futures contract is now down to 37 basis points and it was 75 basis points just a few weeks ago. It's down 12 basis points just today. They're still looking at at rate hikes next year, but now you're talking about the latter part of next year. Now we're looking at one to two rate hikes next year instead of the three the market was pricing in and the four the Fed forecast."

Randy Frederick, managing director, trading and derivatives, at Charles Schwab, said Europe and headlines about Ebola are hurting stocks, in addition to disappointing U.S. data. But he also says the worst of the selling may beover, after the S&P 500 plunged to 1,837 Wednesday morning, an 8.7 percent decline from its September highs. He noted the last hour of trading will be the key.

"I don't really expect it to get to the 10 percent level," said Frederick. "The big question is whether that low that happened between the open and the first 15 to 20 minutes of trading was the bottom. It did seem to find support around 1,839, and then the rally was pretty sharp. We won't really know until the end of the day." But the S&P later broke that level and was trading below 1,830.

The Centers for Disease Control said the second Dallas health-care worker to contract Ebola traveled on a Frontier Airlines plane between Dallas and Ohio a day before showing symptoms, and the CDC and airline are contacting passengers from the flight.

Read MoreNewest Ebola patient flew day before diagnosis

"Europe clearly seems to be going into recession. The data there is not getting better. You compound that with Ebola on top of that and the data today was not good. The only good thing we have is earnings, but that's still backward looking," said Frederick, adding the guidance from earnings will be key.

The weak data puts the focus on the next batch of economic reports, due Thursday. That includes home builders' sentiment, jobless claims, industrial production and the Philadelphia Fed survey.

September's retail sales report showed broad weakness, with softness in most categories. Internet retailers, clothing and home improvement stores all showed declines.

Read MoreRetail sales give cautionary sign on demand

"Consumers have pulled back, pulled back big. It's a little scary out there," Rupkey said.

Manufacturing data for the New York region also showed a slowdown, with the New York Fed's Empire State index plunging to 6.2 percent in October after hitting a five-year high last month.

"Whatever the data is telling us ... it's kind of hard to swallow. Exports were at a record in August. Unemployment is coming straight down. I'm mystified by the data," Rupkey said.