Economic growth slowed in the first half of the year to its slowest pace since the recession ended, the government said early Friday.
High gas prices, less spending by consumers and government cutbacks caused the economy to expand at an annual rate of 1.3 percent in the April-June period, the Commerce Department reported. It revised the first-quarter rate of growth downward to 0.4 percent.
The news overshadowed strong earnings reports from drugmaker Merck & Co. Inc. and oil giant Chevron Corp.
The bad economic news also roiled investors who already were envisioning a worst-case scenario of a US debt default and possible credit downgrade. The Treasury could run out of cash if lawmakers fail to act before Aug. 3.
In morning trading, the Standard & Poor's 500 index fell 15 points, or 1.1 percent, to 1,286. The Dow Jones industrial average dropped 121, or 1 percent, to 12,121. The Nasdaq composite index declined 31, or 1.1 percent, to 2,735.
Traders flocked to bonds, considered to be a safer investment, pushing the yield on the benchmark 10-year Treasury note to 2.87 percent from 2.95 percent on Thursday. As demand for bonds increases, the government is able to pay bondholders lower interest rates, causing yields to fall. Concerns that bond yields could spike on fears of a default have so far been unfounded.
Gold is up about USD 16, or 1 percent, to USD 1,632.3 per ounce. Gold prices tend to rise when investors are nervous about turbulence in other markets.
Traders are growing more anxious about Congress' failure to reach a deal on raising the borrowing limit. Republicans try for the third straight day to pass a bill to raise the borrowing limit while cutting federal spending by nearly USD 1 trillion.
A default by the US could increase borrowing costs for the government and consumers. That could dig the nation into a deeper deficit hole and discourage people from borrowing to buy homes and cars.
Even if Congress does reach a deal, rating agencies could still downgrade US debt, which would have the same effect on borrowing costs.
The debate over increasing the nation's borrowing authority has cast a shadow of uncertainty over the financial markets all summer. Any remaining calm faded before the markets opened Friday, as news of weak economic growth pushed some investors to sell quickly.
The dollar fell 1.3 percent against the Swiss franc and 0.6 percent against the Australian dollar as traders' confidence in the reserve currency eroded.
The market-wide selloff pushed shares of Merck down 2 percent, despite the company's reporting strong earnings before the markets opened. The drugmaker said its second-quarter profit nearly tripled from a year ago. It announced plans to cut 11,830 jobs.
Shares of Chevron also lost a fraction of a percent despite strong second-quarter earnings. The company said its profit jumped 43 percent, beating analysts' estimates, as higher oil and gasoline prices offset a decline in production.
Among the few gainers was travel website operator Expedia Inc. Shares surged 8 percent after the company said its second-quarter net income rose more than expected because bookings increased and prices for plane ticket and hotel rooms rose.