U.S. stocks fell about 1 percent on Wednesday on concerns about the economy in early 2012 while the euro hit a fresh 11-month low against the dollar before a key auction of long-dated Italian debt on Thursday.
Italy's strong sale of short-term bonds this morning initially brought some relief to European markets, but concerns about Thursday's more challenging auction later weighed on sentiment.
Key U.S. stock indexes fell about 1 percent in thin trading volumes as investors worried about what many expect to be a tough beginning of the year. The broad S&P 500 index erased its 2011 gains after just turning positive during last week's rally.
There are clearly some major hurdles on the horizon, said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey. Looking into next year, there is more apprehension about the risks associated with the current climate.
The Dow Jones industrial average lost 119.58 points, or 0.97 percent, to 12,171.77, while the Standard & Poor's 500 Index fell 13.11 points, or 1.04 percent, to 1,252.32. The Nasdaq Composite Index was down 27.31 points, or 1.04 percent, at 2,597.89.
Wall Street's decline weighed on European stocks, which erased earlier gains. The FTSEurofirst 300 index of top European shares fell 0.71 percent to end at 983.32, after rising as much as 0.63 percent earlier.
The MSCI All-Country World index lost 1.22 percent, increasing losses for the year so far to more than 10 percent.
U.S. crude oil prices fell 1.59 percent to $99.68 a barrel. They had gained more than a dollar in the previous session following Iran's threat to stop oil shipments through the Strait of Hormuz if Western countries impose new sanctions on its exports.
Tehran faces the prospect of further sanctions from the European Union by the end of January over its nuclear ambitions. Washington said it saw an element of bluster in the threat to close the Gulf.
The threat by Iran to close the Strait of Hormuz supported the oil market yesterday, but the effect is fading today as it will probably be empty threats as they cannot stop the flow for a longer period due to the amount of U.S. hardware in the area, said Thorbjoern bak Jensen, oil analyst with Global Risk Management.
The euro slid to a session low of $1.2938, its lowest since January, as investors worried about an Italian sale of 8.5 billion euros worth of debt with maturities of up to 10 years on Thursday.
Earlier, the European single currency briefly rose against the dollar after Italian short-term debt costs halved at a Wednesday auction, helped by a new government austerity package and cheap liquidity from the European Central Bank.
Italy will need greater commitment from international investors to sell its bonds on Thursday, however.
Tomorrow's auction is more important and will give more insight into general sentiment. Today was a warm-up, said Neil Mellor, currency strategist at Bank of New York Mellon.
Another factor contributing to the euro's weakening was a report by the European Central Bank that showed regional banks were still taking on liquidity to build reserves instead of adding risk.
There appeared to be reluctance among European banks to lend to each other or invest in euro-zone sovereign debt, analysts said, despite the ECB's recent massive liquidity injection through a three-year refinancing operation.
If European banks are still this concerned, it's not a good sign, said Karl Schamotta, senior markets strategist with Western Union Business Solutions. That, in turn, means we're looking at a potential impact on growth in the new year.
(Additional reporting by Edward Krudy and Luciana Lopez; Editing by Kenneth Barry and; Jan Paschal)