The Dow (.DJI) narrowly missed confirming a bear market as a deepening downturn in business activity across the euro zone, and U.S. business activity contracting for a third straight month in September, left Wall Street wallowing in a sea of red.

The British currency and debt prices weakened further after the UK government announced huge debt-financed tax cuts that will boost borrowing, sending UK bond yields vaulting higher in their biggest daily increases in decades. 

The euro plummeted to a 20-year low and sterling to a 37-year low, while the dollar soared after the Federal Reserve this week signaled rates would be higher for longer.

George Goncalves, head of U.S. macro strategy at MUFG, said the Fed wanted financial conditions to tighten and high interest rates were the mechanism to deliver a market investors had not seen for a long time.

"It's something we're not used to, that's why it's more surprising for most," he said. "It's going to be a long staring contest between the Fed and the markets, and in the middle is the economy which is not responding yet to this tightening."

MSCI's world stocks index shed 2.07% to almost two-year lows.

The pan-European STOXX 600 index (.STOXX) closed down 2.34%, its biggest weekly loss in three months.

On Wall Street, the Dow Jones Industrial Average (.DJI) fell 1.62%, the first major U.S. stock index to fall below its June trough on an intraday basis. But the blue-chip index averted confirming a bear market, as it missed closing 20% or more lower than its record high, according to a widely used definition.

The S&P 500 and the Nasdaq Composite, already in bear market territory, fell 1.72% and 1.85, respectively.

Britain, Sweden, Switzerland, Norway and other countries also hiked rates this week.

But the Fed's signal that it expects high U.S. rates to persist through 2023 sparked the rout in equity and bond markets.

Investors are trying to get a handle on inflation and how high rates will go, said Andrzej Skiba, head of the BlueBay U.S. fixed income team at RBC Global Asset Management.

"There's unease in the market about having confidence that we know how inflation will develop and that yields will indeed peak in the mid-high 4s," he said, referring to a Fed projection of the fed funds rate at 4.6% in late 2023.

"People have been reflecting on that uncertainty and it might mean more tightening ahead, it might mean even more tightening of financial conditions that the markets have to go through."

The euro fell for a fourth straight day, sliding 1.49% to $0.9689 after data showed the downturn in the German economy worsened in September.

The dollar index rose 1.6%.

The Japanese yen weakened 0.68% to 143.34 per dollar, but failed to notch its first weekly gain in more than a month. On Thursday, Japanese authorities intervened to support the currency for the first time since 1998.

UK bond prices went into a tailspin, with yields on the five-year gilt leaping 51.4 basis points to 4.052%, the largest one-day rise since at least late 1991, according to Refinitiv data, after the government unveiled tax cuts.

A bond's price moves counter to its yield.

Sterling fell 3.49% to $1.0864 in its biggest single-day decline since March 2020 when the COVID-19 pandemic rocked markets. The pound was already under pressure before the tax cut announcement, down 11% since the start of July.

"Typically looser fiscal and tighter monetary policy is a positive mix for a currency - if it can be confidently funded," said Chris Turner, global head of markets at ING.

"Here is the rub - investors have doubts about the UK's ability to fund this package, hence the gilt under-performance."

The dollar hit its highest in two decades and extended its double-digit gains for the year against several currencies.

Original Story By | Herbert Lash, Amanda Cooper & Tommy Wilkes