By Herbert Lash
NEW YORK (Reuters) - Stocks sold off on Wall Street, the dollar tumbled and U.S. government debt plunged on Thursday on fears the growing U.S. deficit could lead to a credit rating downgrade after Britain got a wake-up call.
The simultaneous decline in stocks, bonds and the dollar marked a departure from a steady pattern in which investors have taken refuge in bonds and the dollar when stocks have fallen and vice versa.
Some investors read it as a sign of growing worry over the amount of debt the U.S. government is issuing to counter the recession.
Bill Gross, the co-chief investment officer of fixed-income powerhouse Pacific Investment Management Co, was among those who said a move by Standard & Poors to cut its outlook on Britain's debt had set off fears for the United States.
U.S. Treasury debt fell sharply after the government said it would sell $101 billion (63.7 billion pounds) of new notes next week, adding to worries whether investors can digest all the debt the government is issuing to pay for its financial bailouts.
The dollar plunged to its lowest level this year against major currencies and gold rose above $950 an ounce to nearly a two-month high as investors flocked to bullion as a safe haven.
The euro gained 1 percent to trade at $1.3899, after hitting $1.3923 -- its highest level since early January -- while the dollar briefly dipped below 94 yen, a two-month low, before clawing its way back to 94.25 yen, still down 0.6 percent.
"People are asking, if the UK is having problems like this then maybe U.S. sovereign debt is also not as solid," said David Dietze, chief investment strategist at Point View Financial Services in Summit, New Jersey.
Alan Ruskin, chief international strategist at RBS Greenwich Capital, also said Britain's outlook may in the long term be seen as an early warning for other heavily-indebted countries, particularly the United States.
An S&P spokesman declined to comment on the U.S. outlook and noted the agency reaffirmed an AAA rating on the United States in January.
U.S. Treasury Secretary Timothy Geithner made a reference to U.S. debt when he addressed a congressional panel, saying the United States would need to ratchet down its budget deficit swiftly once growth was restored.
"We must get our fiscal house in order or risk having government borrowing crowd out productive private investment," he said.
Geithner also said the U.S. administration has to make sure its policies help retain confidence in the dollar's value.
The S&P warning further soured investors who already were glum after a disappointing report on the American labour market quashed hopes that the U.S. economy was poised for recovery.
The Philadelphia Federal Reserve Bank said its business activity index improved to minus 22.6 in May versus minus 24.4 in April -- but the reading was still weaker than economists' expectations of minus 18.0.
The Dow Jones industrial average <.DJI> closed down 129.91 points, or 1.54 percent, at 8,292.13. The Standard & Poor's 500 Index <.SPX> was down 15.14 points, or 1.68 percent, at 888.33. The Nasdaq Composite Index <.IXIC> was down 32.59 points, or 1.89 percent, at 1,695.25.
Peter Kenny, managing director at Knight Equity Markets in Jersey City, New Jersey, said the U.S. labour data did not justify the rally in stocks since their fall to decade lows in March.
"What it really is telling us is that we're in for a very slow and deliberate turn before we can really start building a solid foundation for the next move up in the market," he said.
Shares of big manufacturers dropped, and investors also pummelled technology shares.
European shares fell, weighed by banks and commodities, as S&P's potential UK credit cut added to worries sparked by news on Wednesday that Federal Reserve policy-makers had cut their U.S. growth forecasts over the next three years.
The pan-European FTSEurofirst 300 <.FTEU3> index of top shares fell 2.1 percent to 857.52 points, breaking five successive sessions of gains.
Benchmark euro zone government bond rallied, outperforming UK gilts as well as higher yielding regional peers, after S&P's credit rating outlook for Britain.
The U.S. 10-year Treasury notes slid 1-17/32 in price to yield 3.37 percent. The 30-year bond traded 3-7/32 lower to yield 4.33 percent.
Oil was dragged down from six-month highs as the lingering signs of U.S. job market weakness stoked concerns about the economy and fuel demand.
U.S. crude settled 99 cents lower at $61.05 a barrel after hitting a six-month high over $62 on Wednesday. London Brent fell 66 cents to settle at $59.93 a barrel.
U.S. gold futures for June delivery settled up $13.80 at $951.20 an ounce in New York.
Asian stocks slipped overnight on the Fed's lowered growth forecasts. Japan's Nikkei average <.N225> fell 0.9 percent as the yen strengthened and MSCI's index of Asian shares outside Japan <.MIAPJ0000PUS> eased 0.5 percent.
(To read Reuters Global Investing Blog click on http://blogs.reuters.com/globalinvesting. For the MacroScope Blog click on http://blogs.reuters.com/macroscope. For Hedge Fund Blog click on http://blogs.reuters.com/hedgehub)
(Reporting by Chuck Mikolajczak, Wanfeng Zhou and Chris Reese in New York; Joanne Frearson, Ian Chua, Catherine Bosley, Jane Merriman and Jan Harvey in London; writing by Herbert Lash; editing by Eddie Evans)