Prospects of a budget breakthrough that would allow the United States to raise its debt ceiling and avoid default on its bond payments faded over the weekend as lawmakers missed a self-imposed deadline to produce a deal.
Gold hit a record high and the dollar fell to a record low against the Swiss franc.
Also weighing on markets was Moody's decision to cut Greece's credit rating further into junk territory. Moody's said it was almost certain to slap a default tag on Greek debt as a result of a new EU rescue package.
Analysts warned of further sharp selling in stocks if Washington fails to increase the debt limit and enters a technical default on its debt next month; analysts have priced in a roughly 10 percent chance of such a scenario.
Many investors are still clinging to the hope that the two major US political parties will reach a compromise to increase the $14.3 trillion borrowing ceiling by Aug. 2.
"If politicians don't find a solution right now, we are facing a disaster of major proportions," said Fidelio Tata, head of US rates strategy at SG Corporate & Investment Banking in New York.
The Swiss franc was the biggest beneficiary of the demand for safe havens, pushing the dollar down nearly 2 percent to an all-time low of 0.8021 franc. The euro fell the same amount versus the Swiss currency, and against the dollar it fell as low as $1.4323.
Spot gold hit a new peak at $1,622.49 an ounce and was up 1.1 percent at $1,616.00.
Gold was on track for its biggest monthly gain since April on concerns over euro zone debt levels as well as the US budget negotiations.
On Wall Street, the Dow Jones industrial average was down 61.46 points, or 0.48 percent, at 12,619.70. The Standard & Poor's 500 Index was down 6.80 points, or 0.51 percent, at 1,338.22. The Nasdaq Composite Index was down 13.64 points, or 0.48 percent, at 2,845.19.
The MSCI world equity index fell 0.37 percent.
Longer-dated US Treasury yields rose and European shares lost ground as the debt impasse in Washington stirred more worries that political wrangling between lawmakers will prompt a cut in the United States' AAA credit rating.
The benchmark 10-year US Treasury note was down 7/32 in price to yield 2.99 percent.
The pan-European FTSEurofirst 300 was down 0.29 percent at 1,105.69, and the Stoxx Europe 600 bank index fell 2.8 percent.
Brent oil futures dropped below $118 a barrel after the weekend breakdown of US budget talks in Washington, before paring losses. Brent crude for September was 50 cents lower at $118.17 a barrel.
US oil was 42 cents lower at $99.45.
Copper prices also came under selling pressure, then steadied as the lower dollar and tight supply outlook helped shield its from concerns about the US debt outlook. Aluminum, used in transport and packaging, touched $2,611.75, its highest level since June 15.
"We have a situation where if they don't get an agreement on raising the US debt level that will be bearish for all assets," said Robin Bhar, analyst at Credit Agricole. "But bizarrely the weakening dollar is supporting commodities.
Copyright Reuters, 2011