The S&P/ASX200 has closed down 2 per cent at 5062.4, as slower Chinese manufacturing activity in May combined with signs that the US Federal Reserve could start rolling back its bond-buying program to send the local sharemarket to its biggest fall in two months.
At the close today, the benchmark S&P/ASX200 index was down 103 points, or 1.99 per cent, at 5062.4 points and value rose to $7.1 billion from $5.1bn yesterday while the broader All Ordinaries index was down 101.3 points, or 1.97 per cent, at 5040.8.
On the ASX 24, the June share price index futures contract was 99 points lower at 5072 with 42,457 contracts traded.
"What surprised all asset classes is that there was debate at the Fed about tapering the pace of bond purchases as soon as the June meeting," Bell Potter managing director Charlie Aitken said.
"Central banks and global investors have spent the best part of six years diversifying away from the US dollar. Now that reverses in my view and we are all underestimating the wall of money that will return to its natural home - the US dollar - from all forms of short US dollar carry trades."
Overseas selling dominated as the Australian dollar dived to a fresh 12-month low.
The Aussie was changing hands at US96.46c, having traded as low as US96.26c. The currency has fallen by more than 7 per cent against the US dollar since the start of the month.
"Feedback is that it will take a month or two to flush out the offshore investors and during that period of time the market could fall 300-400 points," said BBY institutional dealer Anson Rosewall.
Asian markets also fell sharply, with Tokyo stocks tumbling to their sharpest loss in more than two years.
The Nikkei Stock Average lost 1143.28 points, or 7.3 per cent, to 14,483.98, following the prior session's 1.6 per cent rise.
On a percentage point basis the fall was the worst since the volatility-punctuated aftermath of the March 2011 earthquake and tsunami that devastated Japan's northeast region. The Nikkei tumbled 10.55 per cent on March 15.
Participation levels were the heaviest in the history of the Tokyo Stock Exchange, topping 7.655 billion shares. The value of all trades was also very high, totalling 5.837 trillion yen.
A combination of factors contributed to the sell-off, said market players. Fresh Japanese government bond 10-year yields hitting 1 per cent was a clear negative, while weaker preliminary HSBC China Manufacturing PMI data appearing midday comprised a second sell cue.
The purchasing managers index fell to 49.6 in May, a seven-month low, compared with the final reading of 50.4 in April. A reading below 50 indicates a contraction in manufacturing activity.
"The negative Chinese indicator triggered today's selling," said Hirokazu Fujikiki, strategist with Okasan Securities. "It was no wonder if sizeable selling could emerge as Japanese shares rose quite fast recently."
Hong Kong's Hang Seng Index fell 1.6 per cent, though the Shanghai Composite Index in mainland China remained resilient, gaining 0.1 per cent.
South Korea's Kospi Composite was 0.7 per cent lower.
The disappointing news from China added to the broad weakness earlier in the session after Federal Reserve chairman Ben Bernanke told lawmakers that the Fed could start reducing its $US85 billion-a-month bond-buying program.
"In the next few meetings we could take a step down" on bond purchases, Mr Bernanke said overnight.
Minutes from the central bank's last policy meeting showed that some officials were prepared to start pulling back the program as early as its June meeting. Although the group as a whole was not in complete agreement, the minutes further raised expectations that there could be a change in monetary policy.
In the local sharemarket, high-yield stocks were among the worst affected by the prospect of rising US bond yields as the market anticipated a tapering of the Fed's bond purchases.
Big banks fell between 2.8 per cent and 4.1 per cent, Telstra lost 3.7 per cent, Sydney Airports dived 3.7 per cent, toll-road operator Transurban lost 3.6 per cent and utility SP AusNet fell 6.2 per cent.
Property trusts remained weak with Goodman, Stockland, GPT and Mirvac down between 2.9 per cent and 4.2 per cent.
Among resources stocks, BHP Billiton, Rio Tinto, Newcrest and Fortescue Metals fell between 1.1 per cent and 2.8 per cent after the China manufacturing data disappointed the market.
"The cooling manufacturing activities in May reflected slower domestic demand and ongoing external headwinds," HSBC economist Qu Hongbin said in a statement. "The further signs of labor market slackness call for more policy support. Beijing still has fiscal ammunition to do so."
Non-resources offshore-income earners including News Corp, QBE, Brambles and Amcor rose between 0.8 per cent and 6.6 per cent on the back of US dollar strength.
After the close billionaire James Packer-controlled casino company Crown sold its entire 10 per cent of rival Echo Entertainment Group for about $264 million. The shares were sold to institutional investors through UBS for $3.20 each representing 7 per cent discount to today's closing price at $3.44.
