European shares fell sharply on Tuesday and the dollar firmed against the euro amid worrying signs of contagion in the eurozone.
Concern was focused on Italy and Spain with spreads between yields on their sovereign bonds and those of Germany hitting record levels, dampening hopes that the eurozone debt crisis may soon be over.
In the US, a downbeat consumer spending report overshadowed the expected passage of the debt-ceiling deal in Congress.
London's benchmark FTSE 100 index of top shares was down 0.97 percent at 5,718.39 points. In Frankfurt, the DAX fell 2.26 percent to 6,796.75 points and in Paris the CAC 40 dropped 1.82 percent to 3,522.79 points.
On the bond markets, investors sold down Spanish and Italian bonds on concerns that their debt problems would only get worse as economic growth slows.
The premium demanded for buying Spanish 10-year bonds over safe-bet German bonds surged to more than four percentage points -- 404 basis points -- the highest since the introduction of the euro in 1999.
Meanwhile the yield on German government bonds fell below the country's inflation rate for the first time since reunification in 1990 -- dropping to 2.395 percent compared to the 2.4 percent July inflation rate, as investors sought a safe haven.
German bonds "certainly haven't been interesting for investors for a long while in terms of return, but they remain one of the only safe bets in view of the crisis with which we are confronted," said Natixis bond strategist Rene Defossez.
Other European markets also dropped sharply: Milan fell by 2.53 percent, Madrid by 2.18 percent and in Zurich, the leading index fell by 4.09 percent after being closed on Monday for a national holiday.
With troubling eurozone news and a debt deal all but certain in the US, the European single currency sank as low as $1.4158, which was the lowest level since July 21. It later stood at $1.4192 in London deals, down from $1.4248 late in New York on Monday.
"The financial turbulences around the US and the eurozone debt crises have started to cross the species barrier from financial markets to the real economy," Holger Schmieding, economist at Berenberg Bank in Germany said.
"If Europe gets its act together soon, the overall damage to confidence from the US and European debt crises could remain modest... But if the ECB waits much longer before it steps in to contain the eurozone debt crisis, the damage to confidence and growth could become more significant."
Chris Weston, an analyst at IG Markets trading group said, news of a debt deal in the US was quickly overshadowed: "So much for the relief rally that was supposed to occur on the back of the proposed debt deal."
Under the agreement reaced late Sunday by President Barack Obama and top lawmakers, the US government's debt limit will be increased by about $2.4 trillion in two steps while Washington also makes deep spending cuts.
The US Treasury has said that the $14.29-trillion debt ceiling must be raised by Tuesday or else it could be forced to default on its debts, with potentially calamitous effects.
The debt deal, approved by the House of Representatives late on Monday, was expected to pass in the Senate on Tuesday.
But adding to traders' woes was a raft of weak figures from the United States and other major economies.
A debt deal "means markets have become more able to focus on the more mundane matters of economic data, not only in Europe and the United States, but also in Asia as well," said CMC Markets analyst Michael Hewson.
The US manufacturing sector was flat in July, according to a closely watched index released Monday, in another sign of how the economy has stalled.
The Institute of Supply Management's indexed survey of purchasing managers was at 50.9, down from 55.3 the previous month. A reading above 50 indicates expansion.
Manufacturing in China, an economy on which many other nations rely to drive growth, also slowed abruptly -- with one survey suggesting contraction -- while there was similar bad news in Australia, Taiwan and India.
In midday trading in the United States, the Dow Jones Industrial Average was down 0.87 percent to 12,026.99. The broader S&P 500 dropped 1.07 percent to 1273.19 while the tech-heavy Nasdaq Composite shed 0.86 percent to stand at 2,720.96.
Asian markets also stumbled. Hong Kong closed down 1.07 percent, Tokyo sank 1.21 percent, Seoul slumped 2.35 percent and Shanghai shed 0.91 percent.