Stocks tumbled and the dollar surged Thursday after a warning from the Federal Reserve that the United States faced a grim economic outlook with significant downside risks and data offered more evidence of a slowdown in China.

European markets were expected to fall around 3 percent after a slump of more than 4 percent on Asian exchanges, while commodities and emerging market currencies also dived in a broad sell-off of riskier assets.

It is hard to ignore the macroeconomic picture, Tony Nunan, a risk manager with Tokyo-based Mitsubishi Corp., told Reuters.

The dollar jumped to a seven-month high on the prospect of higher short-term interest rates after the Fed said it would sell $400 billion of short-term Treasury bonds to buy longer-dated debt.

The widely predicted Fed move, known as Operation Twist, aims to stimulate the economy by forcing down long-term borrowing costs.

But it was the central bank's bleak assessment of the world's biggest economy that preoccupied markets, with some investors also disappointed that there were no bolder stimulus moves, given the extent of the Fed's pessimism.

I'm surprised to see so much risk aversion after the Fed, said Teppei Ino, a currency analyst at Bank of Tokyo-Mitsubishi UFJ in Tokyo.

I didn't think that many people had expected the Fed to expand its balance sheet, but it seems like some had been wishing for a bolder easing move.

Financial bookmakers called the FTSE 100 <.FTSE> to open down 2.7 percent and forecast other major European exchanges would drop between 2.7 and 3 percent. <.EU>

Japan's Nikkei <.N225> fell 2.0 percent, while MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> dropped 4.5 percent to a 14-month low as capital outflows hammered emerging market strongholds such as Hong Kong <.HSI> and Indonesia <.JKSE>.

Selling accelerated on Asian stock markets after HSBC's China Flash PMI survey showed factory output fell for a third consecutive month in September, pointing to a slowdown in the world's second largest economy.

The data suggested that China, the engine room of global growth in recent years, may not be able to provide much of a counterweight to flagging U.S. and European growth.

The twin fears of U.S. recession and a banking crisis brought on by Europe's sovereign debt woes have haunted equity markets in recent months and fueled a sharp sell-off in early August and renewed weakness this month.

Emerging Asian equities have underperformed U.S. stocks since the August falls, with the MSCI Asia ex-Japan index now nearly 25 percent below its 2011 high in April.

TWIST FAILS TO STIR

Operation Twist is the latest in a series of steps aimed at reviving an economy that has struggled to rebound from the 2008 financial crisis.

But investors worry that the Fed's latest plan will have little effect on lending in an economy that appears to be stagnating, which the Fed also noted.

U.S. stocks suffered their worst one-day drop in a month after the central bank wrapped up its two-day policy meeting on Wednesday, with the S&P 500 index <.SPX> falling nearly 3 percent. S&P index futures traded in Asia fell 0.7 percent, suggesting further weakness when trading resumes.

The dollar rose broadly, with the dollar index <.DXY>, which measures the greenback against a basket of major currencies, gaining 0.9 percent to a seven-month high.

As investors sought safety in the highly liquid dollar, currencies of emerging economies such as the Brazilian real and the South African rand made their biggest daily losses since the 2008 crisis.

Benchmark offshore dollar/yuan forwards rose sharply, implying the Chinese currency would depreciate in 12 months, a dramatic reversal of one of the core bets that foreign exchange markets have held all year.

EURO EASES

The euro eased to $1.3540, heading back toward a seven-month low of $1.3495 struck last week, and hit a 10-year trough versus the yen -- another benefactor of dampened risk sentiment -- at 103.67 before recovering to around 103.95.

U.S. Treasuries extended gains made after the Fed's announcement, with the 10-year Treasury yield falling to a new 60-year low at 1.82 percent.

The Fed's plan to tilt its portfolio toward longer maturities brought the 30-year yield down sharply to 2.94 percent, a fall of 6 basis points on Thursday after a whopping 22 basis points drop on Wednesday.

Japanese government bonds also gained, with the benchmark 10-year yield falling as much as 2 basis points to 0.965 percent, its lowest since November.

The Australian dollar, sensitive to expected demand for commodities -- especially from China -- dipped below parity with the U.S. dollar for the first time since Aug. 9.

Oil and copper, both influenced by expectations of industrial demand, slipped further.

Brent crude was down 1.5 percent at $108.65 a barrel and U.S. crude lost 1.6 percent to $84.49. Copper fell more than 3 percent to $8,045 a metric ton, its lowest level since November.

(Additional reporting by Antoni Slodkowski in Tokyo; Editing by Richard Borsuk)