Wall Street sank on Monday after China defied Washington by announcing retaliatory tariffs, the latest salvo in the two countries’ increasingly belligerent trade war, sending the equities market tumbling.

All three major domestic equity indexes closed in negative territory in a widespread sell-off, with the tech-heavy Nasdaq posting its largest one-day percentage loss this year. The S&P 500 index and the Dow Jones Industrial Average index had their largest percentage declines since Jan 3.

China said it would impose higher tariffs on $60 billion in U.S. goods Trump’s warnings not to retaliate against additional tariffs on Chinese imports announced by the White House on Friday. The move stoked fears of a global economic downturn.

Treasury yields fell to six-week lows, with 10-year yields falling below those of 3-month bills, an inversion seen by many as a potential harbinger of recession. Gold prices rose to a near three-month high.

The CBOE Volatility index, a gauge of investor anxiety, posted its biggest daily point gain so far this year.

Of the 11 major sectors of the S&P 500, only the utilities sector closed out the trading day in positive territory. Trade-sensitive tech companies suffered the largest percentage decline.

Among stocks particularly vulnerable to U.S.-China tariffs, Boeing slid 4.9% and Caterpillar fell 4.6% while the Philadelphia Chip index was down 4.7%, posting its largest percentage drop since January 3, thereby extending last week’s 6% decline.

Shares of Apple were down 5.8% on the double whammy of heightened trade tensions and a decision by the Supreme Court to allow an antitrust lawsuit accusing the company of monopolizing the iPhone app market.

Uber extended its slide, falling 10.8% on its second day as a publicly traded company following Friday’s underwhelming debut. Ride-hailing peer Lyft was also down, dropping 5.8%.

Shares of Tesla fell 5.2% to their lowest in more than two years.

First quarter reporting season is in the home stretch, and of the 451 companies in the S&P 500 that have posted results, 75.2% have come in above expectations. The consensus now is that the S&P 500 will see an increase of 1.3% for the January-March period, significantly better than the 2% decrease expected on April 1.

Approximately 8.24 billion shares changed hands on the major domestic equity exchanges, as compared to the 6.97 billion share average over the past 20 trading days.

Fed Sees Risks Due to Weaker Inflation Expectations

A decline in the consumer outlook for inflation and intensifying trade tensions drew caution from the Fed on Monday, due increased market volatility and a renewed set of risks.

Although the Fed has largely discounted the trade war so far as unlikely to derail our economic expansion, a protracted tit-for-tat battle between the United States and China was a different matter that might require a Fed response.

“If the impact of the tariffs – and whatever financial market reaction to those tariffs is – causes more of a slowdown, then we do have the tools available to us, including lower interest rates,” Boston Fed President Eric Rosengren, a voter this year on Fed rate policy, said in an interview with Reuters.

While Rosengren said he was “not necessarily” expecting a rate cut to be necessary, the market sell-off Monday was deep and potentially disruptive to the Fed’s core expectation that interest rates will remain on hold for some time to come.

Fed officials have been careful to say that nothing yet has changed their core outlook, which envisions rates to be held in their current range of between 2.25% and 2.5% until either growth demonstrably weakens and inflation falls further, justifying a rate cut, or faster inflation makes higher rates warranted.

As the trade war intensified over the last few days, however, traders in the federal funds futures market have moved decisively in favor of expecting a Fed rate cut in coming months. 

Data from the CME Group now sees the Fed cutting rates in October, with a near 10 percentage point shift since Friday in the probability of a rate reduction at that Fed meeting.

The pressure on the Fed could come from several directions. Economic growth overall could slow if the tariff wars continue and global trade declines; “wealth effects” could directly impact business and household confidence and spending if the stock declines continue; higher costs could hit company profits and discourage hiring.

A further complication for the Fed: The inflation outlook among U.S. consumers dipped sharply in April, countering Fed policymaker hopes that inflation dynamics will improve, and the pace of price increases soon rise toward their target level.

Survey data released by the New York Federal Reserve on Monday showed consumer expectations of the inflation rate over the next year fell to 2.6% from 2.82% in the March survey. The nearly quarter point drop was the third largest since the survey was launched in mid-2013. The outlook for inflation over the next three years also fell, to 2.69% from 2.86%, evidence that medium-term expectations have also weakened in recent weeks.

Following the Fed’s most recent meeting, Chairman Jerome Powell and others said they felt recent weak inflation readings were driven by “transitory” factors that would disappear over time and allow overall inflation to rise.

But a decline in inflation expectations is another matter, and could be evidence that households and businesses are losing faith in the Fed’s ability to deliver on its inflation goal – a worrying development for central bankers who feel their ability to keep expectations set around their inflation target is critical to meeting the goal.

As of the Fed’s last policy statement on May 1, officials said they felt expectations remained stable.

While consumer surveys are discounted by some officials as overly influenced by things like changes in gasoline prices and other costs that consumers closely monitor, some broader market expectation measures have also shifted. Since late April, for example, a St. Louis Federal Reserve measure of the inflation rate expected five years from now, based on trading in different types of bonds, dipped to 1.9% from 2.1%, a sign that traders see weaker inflation ahead.