President Barack Obama and Democratic and Republican lawmakers met Friday as they faced just days to reach a budget deal to avert massive tax increases and spending cuts that could drag the U.S. economy, the world's biggest, into recession.
The two sides are attempting to smooth over sharp differences on raising taxes on the wealthiest Americans and cutting spending on politically sensitive social welfare programs such as Medicare and Medicaid. But investors were skeptical that a deal could be accomplished before the deadline.
The MSCI all-world share indexwas down 0.5 percent, and the pan-European FTSEurofirst 300ended down 0.6 percent.
In U.S. trading, the Standard & Poor's 500 Indexwas down 15.67 points, or 1.11 percent, at 1,402.43, marking a fifth straight decline for the longest losing streak in three months.
The Dow Jones industrial averagewas down 158.20 points, or 1.21 percent, at 12,938.11, while the Nasdaq Composite Indexwas down 25.59 points, or 0.86 percent, at 2,960.31.
"There's a pretty good chance that we won't have something in hand by year-end," said Jonathan Golub, chief U.S. equity strategist at UBS, in New York. "It should be pretty obvious that that is now the majority case."
Golub, however, said investors were still counting on a deal that would avoid most of the tax hikes and spending cuts next year even if it does come after the deadline.
Allowing $600 billion of higher taxes and spending cuts to start in January would prevent U.S. debt spilling beyond a $16.4 trillion agreed limit. Analysts fear the measures could wipe as much as 4 percent off the country's growth rate.
Energy companies were among the biggest decliners on Wall Street, with shares of Exxon Mobildown 2 percent at $85.10 and the S&P energy indexleading sector losses.
The U.S. dollar edged up to a two-week high against major currencies as investors waited to see if U.S. politicians can strike a last-minute budget deal.
"Headline risk is likely to remain a driver of FX markets in the near term," said Eric Theoret, FX strategist at Scotia Capital in Toronto.
An agreement on the U.S. budget would be viewed as positive for riskier currencies such as the euro and Australian dollar, while a deadlock is deemed positive for the safe-haven and highly liquid dollar.
Against a basket of currencies at 79.930, the dollar was last up 0.1 percent at 79.665 .
At the same time, expectations that Japan will inject new stimulus into its economy pushed the yen to yet another two-year low for a third straight day.
The dollar was steady against the yen at 86.06 yen, having earlier risen to 86.63 yen, its strongest since August 2010.
In the U.S. bond market, benchmark Treasury debt prices rose for a third consecutive session on safe-haven buying as the faded hopes for a deal on the fiscal cliff.
Benchmark 10-year notes traded 12/32 higher in price, with yields falling to 1.69 percent, marking the lowest in two weeks and down from 1.73 percent late Thursday. Benchmark notes posted their biggest daily dip in yield in over seven weeks and were down about 8 basis points on the week.
U.S. February crude slipped 7 cents, or 0.08 percent, to settle at $90.80. Trade was choppy, awaiting news on the U.S. budget talks, but the market was pressured by data showing that fuel stockpiles rose sharply and crude stocks fell less than expected last week.
Brent February crude fell 18 cents, or 0.16 percent, to settle at $110.62.
In other commodity markets, U.S. gold futures for February delivery settled down $7.80, or 0.5 percent, at $1,655.90 an ounce in New York.
Traditionally a safe haven and inflation hedge that investors rush to in times of trouble, gold has lately behaved like a risk asset - often rising and falling with the stock market and sometimes following the dollar.
(Additional reporting by Robert Gibbons, Wanfeng Zhou, Barani Krishnan, Edward Krudy and Karen Brettel in New York; Editing by Kenneth Barry, Dan Grebler and Leslie Adler)