The region's fiscal woes sent the yield on the safe-haven 10-year U.S. Treasury note to the lowest in 60 years and the euro to its lowest level in 23 months against the dollar. U.S. equities have been closely tethered to the currency's fortunes, with a 50-day correlation between the euro and the S&P 500 index at 0.91.
"The longer they (Europeans) drag it out, the less severe are the ramifications of a break-up and then who actually ends up exiting - so much of this is unwritten it is hard to put any sort of odds on how this plays out," said Nathan Snyder, portfolio manager at Snow Capital Management in Sewickley, Pennsylvania.
Yields on 10-year Spanish bonds moved closer to the 7 percent level, a point at which other nations in the bloc were forced to seek a bailout.
Spain is expected to issue new bonds shortly in an effort to fund its troubled banks despite the increased borrowing costs.
Adding to the concern, Italian 10-year yields topped 6 percent for the first time since January at a bond sale, raising concerns the region is vulnerable to a contagion.
Investors were given cause for optimism after the European Commission said the the euro zone should move toward a banking union, consider eurobonds and the direct recapitalization of banks from its permanent bailout fund as well as boost growth and cut debt.
But the cheering was short-lived after the latest poll from Greece showed the radical leftist SYRIZA party has taken the lead over the pro-bailout conservatives ahead of a national parliamentary election next month that may determine whether the debt-laden country stays in the euro zone.
"It seems inevitable the euro has got to break up, it's just how long can they drag it out and what are the ramifications," said Snyder of Snow Capital Management.
The CBOE Volatility index jumped more than 10 percent, it's biggest spike since mid-April.
The PHLX oil service sector dropped 2.9 percent with U.S. crude down more than 2 percent as the euro zone's debt problems and signs China was not planning a large stimulus package stoking demand fears. National Oilwell Varco Inc lost 2.6 percent to $68.19.
European shares were buffeted by the conflicting headlines, with the latest Greek poll pushing the FTSEurofirst 300 index down more than 1 percent.
The Dow Jones industrial average dropped 135.21 points, or 1.07 percent, to 12,445.48. The Standard & Poor's 500 Index lost 16.32 points, or 1.22 percent, to 1,316.10. The Nasdaq Composite Index slumped 40.97 points, or 1.43 percent, to 2,830.02.
U.S. economic data showed contracts to purchase previously owned U.S. homes unexpectedly fell 5.5 percent in April to a four-month low, dealing a blow to more recent optimism the housing sector may have hit a bottom.
Research In Motion Ltd tumbled 10.6 percent to $10.05 as the biggest percentage decliner on the Nasdaq 100 index. The company hired bankers for a far-reaching strategic review and to look for partnerships as the BlackBerry-maker warned it would likely report a shock fiscal first-quarter operating loss.
Apple Inc slipped 0.9 percent to $567.14 after Chief Executive Tim Cook, speaking at the All Things Digital conference said technology for televisions was of "intense interest" but stressed the company's efforts would unfold gradually amid speculation the iPad and iPhone maker was on the brink of unveiling a revolutionary iTV.
Macy's Inc reported better than expected May same-store sales on Wednesday, helped by its growing e-commerce business. Shares slipped 2.9 percent to $37.86.
Pep Boys-Manny, Moe & Jack plunged 21.7 percent to $8.68 in premarket after the automotive parts and service chain said the sale of the company to private equity firm Gores Group has been called off.
(Reporting By Chuck Mikolajczak, editing by Dave Zimmerman)
Copyright 2010 by Reuters. All rights reserved.