Stock Markets Tumble as Investors Bail on Risk

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Global markets slumped on Tuesday in a sell-off that encompassed nearly every major asset class, after the Japanese central bank failed to address recent volatility and investors worried about the end of central bank liquidity. Emerging market currencies were sharply weaker against the greenback, while shares, bond yields and gold all fell.

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U.S. markets dropped 1 percent and the pan-European FTSEurofirst 300 index closed provisionally down 1.2 percent, with Greece declining nearly 5 percent for a second day in a row.

The downturn was triggered after the Bank of Japan (BoJ) opted to keep monetary policy unchanged. Investors had hoped the BoJ would increase the maturities on its fixed-rate loans from one year to two to stabilize markets, and possibly step up its asset purchases program.

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The U.S. dollar-yen fell to a low of 97.78 and the Nikkei slipped 1.5 percent on the news.

"The BoJ should have done something to calm down volatility and the level of the Japanese government bond yields. We had a big collapse in the equity market partly because of high volatility in the Japanese government bond market. It is important the BOJ and government show concern over the correction," Kenji Abe, equity strategist at Citigroup Global Markets Japan, told CNBC.

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Emerging markets were particularly hard hit, suffering a double whammy because of the ongoing strength in Treasury yields and the U.S. dollar, which are driving money out of yesterday's hot markets. Yields on 30-year Treasury bonds reached a new 14-month high of 3.433 percent on Tuesday.

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"The emerging markets in general have been under strong sell-off pressure since this morning, both fixed income and foreign exchange, as the sentiment towards emerging markets is deteriorating further at this time. The likely reason is the disappointing news from Bank of Japan Governor Haruhiko Kuroda, which is negative for emerging markets," said Danske Bank analyst Stanislava Pravdová-Nielsen in a research note.

The Indian Rupee fell to a record low of 58.56 against the greenback on Tuesday, while the Philippine peso hit a one-year low versus the dollar.

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"Some EM currencies have now depreciated by even more than we had expected this year. But while we wouldn't rule out a bounce in a few cases – such as the Brazilian real – by the end of 2013, we still expect further declines in the majority," said Capital Economics' economists Paul Hollingsworth and John Higgins in a research note on Monday.

'This Leopard Has Changed His Spots'

Long-term dollar bear David Bloom told CNBC he had turned bullish on the greenback, joining the wave of foreign exchange analysts who have shifted their outlooks as emerging market currencies continue to sink.

"I am the vegetarian that is now eating meat; this leopard has changed his spots," Bloom, an HSBC strategist told CNBC on Tuesday. "Two or three weeks ago I completely changed my view, and I believe now, for the next six-to-12 months, we are in a beautiful sweet spot for the dollar."

"We believe the tapering argument in the U.S., the China slowdown, the shale gas story, you add them up together and you find you are in a dollar-bullish environment. Plus the European environment is very, very weak. You add to that the currency wars – people are trying to manipulate their currencies lower – and we think we are in a dollar-bullish environment," he added.

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In a report published on May 22, HSBC upped its year-end forecast for the dollar against a number of developed countries' currencies. HSBC now predicts the greenback will stand at $1.45 against the British pound, $1.25 versus the euro, and $0.90 against the Aussie dollar.

"Across the globe, more policymakers are being drawn into the currency war, and their efforts are proving successful. The mirror of this growing pursuit of currency weakness is dollar strength," said Bloom in the report.

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Bloom added that it was unclear whether emerging market shares and bonds will fall to the same extent as their currencies.

"I think equities and bonds are still behaving risk-on, risk-off, but currency is doing its own thing… the question is, will the other two follow?"

—By CNBC's Katy Barnato