The sell-off comes one day after the Dow closed at a record high as investors cheered upbeat reports on home prices and consumer confidence.
But concerns that the Fed might scale back its stimulus policies as the economy improves weighed on the market Wednesday, said Bernard Kavanagh, vice president of portfolio management at Stifel Nicolaus.
"Everyone is afraid the Fed will throw the brakes on and that will drive market down," he said.
Kavanagh said worries about the Fed tapering are "overblown," but added that investors will continue to take their cues from the bond market, where rates have crept up recently.
The Fed has been buying $85 billion worth of long-term Treasuries and other assets every month to push interest rates lower and give the economy a boost. But a number of Fed officials, including chairman Ben Bernanke, have suggested that the central bank could slow the pace of its purchases if the economy continues to strengthen.
Stocks briefly pared losses Wednesday afternoon following a speech by Boston Fed president Eric Rosengren.
Echoing Bernanke's comments, Rosengren said withdrawing stimulus too soon would hurt the economic recovery. But he reiterated that the Fed continues to monitor incoming economic data and stands ready to increase or decrease the pace of its bond buying.
Eye on bonds. The yield on the 10-year U.S. Treasury note rose as high as 2.23%, up from about 1.6% at the end of April. That move pushed the 10-year yield above the dividend yield on the S&P 500 for the first time this year, said Kavanagh.
The rise in yields hit shares of companies that typically pay higher dividends, including utilities, telecoms and consumer staples. The 10-year yield pulled back toward the close to end at 2.12%.
Investors were also rattled by weaker-than-expected demand at the previous day's auction of $35 billion of 2-year Treasury notes, according to Guy LeBas, chief fixed-income strategist at Janney Capital Markets.
Slow news day? With no data on the U.S. economy released Wednesday, investors focused on reports from overseas. The International Monetary Fund cut the growth forecast for China, the world's No. 2 economy. The IMF raised concerns about a rapid expansion in credit there and the ability of borrowers to repay the loans.
Separately, the OECD slashed its outlook for the euro area economy and called on the European Central Bank to do more to fight unemployment and revive growth.
China brings home the bacon. Smithfield Foods (Fortune 500) shares surged 28% after the pork processor and hog producer , agreed to be bought by Chinese meat processor Shuanghui International in a deal valued at $7.1 billion.
The news lifted shares of rival meat processor Tyson Foods. (Fortune 500) ,
Undertaker takeover. Service Corporation (, which provides "deathcare products and services," announced plans to buy rival )Stewart Enterprises ( for $1.4 billion. Shares of Stewart Enterprises surged in early trading. The deal between two of the larger players in the funeral business is subject to regulatory approval. )
Apple (Fortune 500) shares were slightly higher after an appearance at the AllThingsD conference by , CEO Tim Cook Tuesday evening. Cook was evasive about the company's product plans, saying only that the iPhone maker was looking for more "game changers" in its future and that he considered the wearable computing product segment " "incredibly interesting."
Fannie and Freddie soar ... and then plunge. Citigroup (Fortune 500) reached a settlement with the Federal Housing Finance Authority in a suit charging it deceived , Fannie Mae (Fortune 500) and , Freddie Mac (Fortune 500) when it sold the housing finance firms mortgage securities during the housing bubble. ,
Shares of Fannie and Freddie, which trade over the counter as opposed to on a major exchange, both plunged more than 30% in heavy volume after surging earlier in the morning.
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|Overnight Avg Rate||Latest||Change||Last Week|
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