The downgrade by Fitch Ratings ignited a new round of selling in equities that were already lower after lackluster U.S. economic data injected a note of caution ahead of long holiday weekends in both the United States and the UK.
Fitch downgraded Spain's credit rating to AA-plus, and said it expects the country's adjustment to a lower debt level will materially reduce its rate of economic growth over the medium-term.
Fitch cited an inflexible labor market and a restructuring of regional and local savings banks as hindrances to the pace of adjustment.
"This should exacerbate the tremendous volatility we've seen in global stocks as the world wrestles with the idea of a debt-based collapse
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"Adding to this is the fact that no one wants to be long over a holiday weekend."
The euro fell as low as $1.2284, according to electronic trading platform EBS, near a session of $1.2281.
The euro also dropped versus the yen
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The major U.S. stock indexes shed more than 1 percent, and U.S. Treasuries slightly extended gains, hitting session highs after the Fitch downgrade. Benchmark 10-year notes were last up 18/32 in price, yielding 3.30 percent.
Investors had been shunning risk even before the Fitch downgrade on Spain.
A Commerce Department report that U.S. consumer spending failed to rise in April after six straight months of gains
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The Dow Jones industrial average
.DJI was down 119.94 points, or 1.17 percent, at 10,139.05. The Standard & Poor's 500 Index .SPX was down 15.13 points, or 1.37 percent, at 1,087.93. The Nasdaq Composite Index
.IXIC was down 32.14 points, or 1.41 percent, at 2,245.54.
The S&P 500 and the Nasdaq had each fallen more than 1 percent earlier in the day, though had pared losses sharply before the news on Spain sparked a new wave of selling.
Technology bellwether Apple Inc (AAPL.O) managed to buck the downtrend, after Asian and European customers mobbed stores as the
iPad tablet computer debuted outside the United States. Apple shares rose 1.5 percent
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But still pressuring global shares and the euro was concern of contagion from the
Greece debt crisis. Despite the lack of major shocks from Spain, Portugal or Ireland, which all have heavy debt loads, investors were still loathe to add risky assets due to questions of how shakier sovereign credit would affect the economic recovery.
Equities measured by the MSCI All-Country World Index .MIWD00000PUS fell 0.12 percent after earlier hitting a one-week high. The index is down about 9 percent in May and on track for its worst monthly loss since February 2009.
In Europe, markets closed ahead of the downgrade on Spain.
The pan-European FTSEurofirst 300
.FTEU3 index fell 0.3 percent
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"It looked quite bullish earlier, but investors are taking risk off the table going into the weekend and also holidays in the U.S. and the UK on Monday," said Matthew Brown, sales trader at ETX Capital. "They are not keen to hold equities."
Tokyo's Nikkei average
.N225 closed up 1.3 percent in its best one-day performance in two weeks as exporter shares climbed on a halt in the yen's advance.
The Thomson Reuters/University of Michigan consumer confidence index edged higher in April, while the Institute for Supply Management-Chicago's business barometer dropped in May from a five-year high in April, signaling inventory restocking that has driven U.S. growth in recent quarters may be slowing.
Tempered views of global economic strength sent yields on benchmark 10-year Bunds down by 0.01 percentage point to 2.67 percent, and yields on 10-year U.S. Treasuries off by 0.05 percentage points to 3.31 percent.
In energy and commodities, U.S. light sweet crude oil fell 1.1 percent to $73.73 per barrel, and spot gold fell $5.65, or 0.47 percent, to $1,205.40.