The prospect of rising interest rates sent a shudder through the stock market Monday.
As the yield on the 30-year Treasury bond climbed above 6 percent, the Dow Jones Industrial Average dropped below 9,000. Skittish investors raised cash amid fears that the fairy tale-perfect economy is in its last chapter.
The Dow closed at 8,917.64, down 146.98 points, a 1.62 percent decline.
"The two drivers behind stock prices have been rising earnings and falling interest rates," said Steven Bolten, a financial economist and professor at the University of South Florida. "We now have interest rates possibly going back up a little and earnings that are no longer rising like they were."
The bad day for the stock and bond markets began with a report in the Wall Street Journal that the Federal Reserve Board agreed at its closed-door meeting March 31 that higher interest rates may be necessary. The report indicated the Fed might vote to raise short-term rates at its May 19 meeting.
Some Fed officials have made comments recently that they think the economy cannot continue growing at its current strong pace without triggering inflation.
The Fed's usual solution to the threat of inflation is to raise rates, which makes borrowing more costly and puts a damper on growth. Higher rates hurt home and car buyers, who have to pay more for their mortgages and auto loans, but help retirees who earn more interest on their certificates of deposit.
"It's been surprising that we've had this tremendously long period where we have had such limited inflation with such rapid growth," Bolten said. Consumer prices rose just 1.4 percent in the 12 months through March, the smallest increase in more than a decade.
Bolten said falling oil prices and collapsing Asian economies have kept both inflation and interest rates lower than they normally would be. But as the job market gets tighter, companies are under pressure to increase wages, he said.
Stock market investors are nervous about the prospect for higher rates because they would hurt corporate earnings and increase the attractiveness of bonds relative to stocks. One reason stocks have gone up so much is that investors haven't been able to earn much of a return elsewhere.
Speculation that higher rates are around the corner pushed the yield on the 30-year bond to 6.06 percent Monday, the highest level in seven weeks. Opinions are mixed about just what this means for stocks.
"The buzzword this week and in the next few weeks is going to be inflation," said Eugene Peroni, director of technical research at Janney Montgomery Scott Inc. in Philadelphia. "This could trigger a correction as deep as 8 percent," which would take the Dow to 7,350.
Tampa money manager John Bartoletta said he is looking for a decline of about 500 points before jumping back into stocks. Bartoletta, who heads High Street Financial, said his clients have about 65 percent of their money in cash.
"The market just got too extended to the up side," he said.
Clearwater market timer Robert Ferree also is negative on the market. He said last week's trading showed signs of "a speculative climax."
However, Abby Joseph Cohen, a well-known strategist at Goldman, Sachs & Co. in New York, said forecasts like those are overly pessimistic.
"U.S. stock prices tend to move in a staircase pattern in which notable price gains are followed by a trading range," she said. "This pattern seems to be reasserting itself following the sizable gains in recent months."
Hal Marlow, president of MTA Capital Management in Largo, said, "We are entitled to a rebound now, but we are in for a pretty sloppy month of May."
Just because Fed officials are voicing inflation fears does not guarantee that they will follow through with action on interest rates.
"What it really means is that (Fed Chairman) Alan Greenspan is getting very nervous" about the stock market, said Steve Guterman, a fixed-income manager with Salomon Brothers Asset Management in New York. "The Fed is trying to jawbone the market down."
Guterman said he will buy 30-year bonds if the yield rises to 6.10 percent.
Even after Monday's slump, yields remain relatively low from a historical perspective. And the Dow is still up 12.76 percent since the beginning of the year.
_ Information from Times wire services was used in this report.