European stocks tumbled and the euro slid as extended coronavirus lockdowns drove the German government to slash its growth forecast for 2021, while talk of further interest rate cuts by the European Central Bank hit banking stocks.
The pan-European STOXX 600 closed down 1.2% in its biggest single-day percentage fall in more than five weeks.
U.S. equity declines were exacerbated by hedge funds dumping long positions to cover a short squeeze sparked by a sharp rally in GameStop and AMC Entertainment Holdings, which each more than doubled in heavy trade.
Volume the past three days in GameStop has averaged almost 185 million shares a day, an enormous jump from an average 6.73 million shares in the first week of trading this year.
The stampede of retail investors has disrupted the marketplace, taking seemingly rational investments and turning them upside down, said Jack Ablin, chief investment officer at Cresset Capital Management in Chicago.
"The retail investors are identifying the hedge fund fat cats shorting shares and making them pay," Ablin said.
The Dow Jones Industrial Average fell 1.07%, the S&P 500 lost 1.47% and the Nasdaq Composite dropped 1.18%.
MSCI's benchmark for global equity markets fell 1.3% to 657.4, while its index for emerging markets stocks fell 1.05%.
AMC rose 206%, GameStop 131% and Express Inc 255% on the New York Stock Exchange.
Investors parsed through earnings reports from companies including Boeing and Microsoft ahead of the Fed's policy statement at 2 p.m.
Boeing Co posted a record annual loss but shares in Microsoft hit a record high after reporting its Azure cloud computing services grew by 50%.
Quarterly earnings from U.S. tech giants including Facebook and Apple, are due after the bell at 4 p.m.
In currency trading, the dollar index rose 0.403%, with the euro down 0.39% to $1.2113.
The Japanese yen weakened 0.44% versus the greenback at 104.07 per dollar.
U.S. Treasury yields slid in line with weaker stocks as risk appetite hit a wall ahead of the Fed's policy announcement.
The U.S. central bank is likely to maintain its ultra-accommodative policy as the pandemic weighs on the economy, but investors want to see the Fed's economic outlook given likely strong fiscal measures under the new U.S. administration.
Investors see bonds as a safe haven, especially given the short-covering and disruption occurring in equity markets, said Ellis Phifer, market strategist, at Raymond James in Memphis.
"If it continues to spread, you get more margin calls, more firms having to potentially shut down and they're leveraged so they start selling more and you can end up in a bad spot," Phifer said.
The 10-year U.S. Treasury note fell 0.03 basis points to yield 1.011%.
Gold prices fell to a more than one-week low, pressured by concerns over the U.S. stimulus bill and strength in the dollar.
Spot gold prices fell -0.33% to $1,844.18 an ounce.
The International Monetary Fund raised its forecast for global economic growth in 2021, and said the coronavirus-triggered downturn last year would be nearly one percentage point less severe than expected.
Global COVID-19 cases surpassed 100 million on Wednesday and countries around the world are struggling with new variants of the virus and delays in vaccine rollouts.
Oil prices ticked up as a massive drawdown in U.S. crude inventories countered persistent concerns about the coronavirus pandemic continuing to hurt fuel demand.
U.S. crude oil stocks dropped by nearly 10 million barrels last week to their lowest since March at 476.7 million barrels as imports dropped off, the Energy Information Administration said, compared with analysts' expectations in a Reuters poll for a rise in inventories. [EIA/S]
Brent crude futures rose $0.34, to $56.25 a barrel. U.S. crude futures gained $0.57, to $53.18 a barrel.
(Graphic: Fed Balance Sheet: 
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(Reporting by Matt Scuffham and Elizabeth Howcroft; Editing by Nick Macfie, Kirsten Donovan, Jane Merriman and Cynthia Osterman)
By Matt Scuffham and Herbert Lash
