Wall Street and European stock markets dropped sharply as fears of interest rate increases and stagflation upended a narrative of economic recovery and easy monetary policy that has supported asset prices for months.

The blue-chip S&P 500 share index fell nearly 1.7 per cent while the technology-heavy Nasdaq Composite dropped 2.5 per cent. Europe’s Stoxx 600 index fell 1.9 per cent.

The yield on the 10-year US Treasury note, which acts as a benchmark for borrowing costs for companies and households worldwide, added 0.05 percentage points to 1.539 per cent, a level not seen since June.

Government bond yields, which move inversely to prices, have climbed over the last week to track anticipated interest rate rises by the US and UK central banks, who have signalled moves away from pandemic-era monetary stimulus in the face of persistently high inflation.

The 10-year Treasury yield, which traded around 1.3 per cent a week ago, is also a barometer used by investors to assess the value of public companies’ future earnings, cash flows and dividends.

“When bond rates go up it makes equities look less attractive, and particularly those whose dividend yields are very small, such as in the technology sector,” said Rebecca Chesworth, senior equities strategist at State Street Global Advisors’ SPDR ETF business.

Last week, the Federal Reserve said it could easily move ahead with a reduction of its $120bn-a-month of bond purchases. The world’s most influential central bank also revealed that half of its monetary policymakers expect the first post-pandemic interest rate rise in 2022.

“The main market narrative is one of stagflation,” said Samy Chaar, chief economist at Swiss bank Lombard Odier, referring to the spectre of high inflation and a slower economic expansion due to energy price rises and “growth worries coming out of China.”

A day later the Bank of England warned UK inflation could top 4 per cent into next year, sparking expectations it was moving closer to raising interest rates from record lows.

The UK 10-year gilt yield climbed 0.05 percentage points on Tuesday to breach 1 per cent for the first time since March 2020. Sterling dropped almost 1.2 per cent against the dollar to purchase $1.354.

Testifying to Congress on Tuesday, Fed chair Jay Powell said that supply side constraints that have kept headline US inflation above five per cent for three consecutive months were “larger and longer lasting than anticipated.”

Powell made these comments hours after Brent crude, the international oil benchmark, crossed $80 a barrel for the first time since October 2018, driven higher by hurricanes curtailing US production and surging natural gas prices.

The US Conference Board’s consumer confidence index, published on Tuesday, also hit a seven-month low in September. The study’s authors cited concerns about the highly infectious Delta variant of coronavirus for the drop.

Investors are still waiting to see whether Beijing authorities will manage to contain any spillover from a debt crisis at Evergrande, a major Chinese homebuilder that missed an interest payment on bonds held by foreign investors last week.

Chaar added that if central banks raising rates coincided with above-trend economic growth next year, stocks with higher dividend yields, such as those in the banking and energy sectors, could outperform.