The euro fell to under $1.26 and European stocks declined as investors shunned riskier assets on worries about Greece's possible departure from the euro zone, which would deepen the region's debt crisis and hurt an already fragile global economy.
Greece's former prime minister, Lucas Papademos, said that while it's unlikely the nation will leave the euro, it remains a risk, according to a report in the Wall Street Journal.
Each euro zone country will have to prepare a contingency plan for the eventuality of Greece leaving the single currency, three euro zone sources told Reuters, citing an agreement reached by officials.
A scramble for low-risk investments enabled Germany to pay no interest on a new two-year debt issue amid the absence of new measures from a European leaders' summit in Brussels to tackle the region's debt crisis.
"The markets are on edge and sensitive to every possible out-of-control scenario coming out of Europe," said Peter Boockvar, equity strategist at Miller Tabak & Co in New York.
Europe's leaders are expected to discuss boosting growth at a meeting later today, as well as the idea of a joint euro-zone bond. French president Francois Hollande supports the bond plan, but German chancellor Angela Merkel opposes it.
"Most are expecting no concrete solution out of the meeting, just a few ideas discussed on how to boost growth with no real commitment to carry them out, while Angela Merkel is almost certain to reject any proposal by Francois Hollande in relation to euro bonds," said Craig Erlam, market analyst at Alpari.
Perception of a stalemate between the head of the euro zone's most powerful member and leaders of other euro countries unleashed selling of their common currency and shares worldwide.
The MSCI world equity index tumbled 1.7 per cent to 298.10, close to the lowest level of the year set last week. The Dow Jones industrial average was down 131.46 points, or 1.05 per cent, at 12,371.35. The Standard & Poor's 500 Index was down 12.49 points, or 0.95 per cent, at 1,304.14. The Nasdaq Composite Index was down 20.65 points, or 0.73 per cent, at 2,818.43.
The FTSE Eurofirst index of top European shares lost 1.9 per cent to 974.42, while the Nikkei index shed 2 per cent to 8,556.60.
The euro fell 0.3 per cent to 1.2593 after touching $1.2613, its lowest level since August 2010.The dollar index rose 0.3 per cent to 81.74 after touching 81.91, its highest since September 2010.
"The euro's downtrend is entrenched and we think there are too many risks of potentially nasty outcomes in the euro zone, especially with regard to what will happen to Greece," said Ned Rumpeltin, currency strategist at Standard Chartered in London.
Fears about a Greek exit from the euro were stoked by former prime minister Mr Papademos, who said late yesterday that Greece had no choice but to stick with a painful austerity program or face a damaging exit from the euro zone.
Mr Papademos' comments fed bidding for German and US government debt as investors sought low-risk investments.
The strong German Schatz auction lifted June Bund futures 91 ticks to 144.00, while benchmark US Treasury yields were around 1.72 per cent, within striking distance of the lowest level at least 60 years.
In the oil markets, signs of a potential deal between Iran and the UN's International Atomic Energy Agency to block investigations of suspected work on nuclear weapons in the oil-producing country sent Brent crude below $107 a barrel.
Brent last traded down $1.53 at $106.88, while US oil futures fell 73 cents to $91.12 a barrel.
Spot gold prices fell for a third straight session, down 1 per cent to $1,550.01 an ounce.
Reuters, Bloomberg