NEW YORK (Reuters) - Stock markets fell and the euro hit a two-year low on Tuesday as rising Spanish bond yields drove Madrid closer to a full-scale bailout, while Greece's membership in the euro zone was at risk as its finances were way off its rescue package aid terms.
Equities were also pressured by lowered 2012 U.S. profit forecasts, including United Parcel Service (UPS.N), the world's largest package delivery company. Risk aversion drove the benchmark U.S. 10-year Treasury note yield to a fresh historic low.
Spanish yields climbed above 7.6 percent on its 10-year bond, reflecting a growing belief that the country will need a bailout that the euro zone can barely afford.
As inspectors from Greece's three international creditors return to Athens to decide whether to keep a 130-billion-euro lifeline active, three European Union officials said they were likely to conclude the country cannot repay what it owes.
"People are jumping to the conclusion (Greece) won't get any more money than (what) they need to in order to pay back the ECB and therefore they will exit the euro," said Gail Dudack, chief investment strategist at Dudack Research Group in New York.
She said she didn't see the Greek exit as imminent but "much further out in history."
The Dow Jones industrial average .DJI fell 167.90 points, or 1.32 percent, to 12,553.56. The S&P 500 Index .INX .SPX dropped 17.31 points, or 1.28 percent, to 1,333.21. The Nasdaq Composite .IXIC lost 29.44 points, or 1.02 percent, to 2,860.71.
The MSCI world equity index fell 1 percent after losing 1.7 percent on Monday. The FTSEurofirst 300 index of top European shares closed down 0.55 percent a day after a 2.4 percent drop.
Italy's benchmark FTSE MIB stock index fell 2.7 percent to close at its lowest since the 1999 launch of the euro.
Further weighing on Wall Street, U.S. manufacturers lowered 2012 sales and profit forecasts even as several companies reported higher-than-expected quarterly earnings.
Shares of UPS, seen as a bellwether of the overall economy, dropped more than 5 percent, and its main rival FedEx lost more than 2 percent.
"You look at UPS and FedEx and you think they are sort of the temperature-takers of what is going on. If they are tanking, why should I step in front of that moving train?" said Cummins Catherwood, managing director at Boenning and Scattergood in West Conshohocken, Pennsylvania.
The euro hit its lowest since June 2010 versus the U.S. dollar, down 0.5 percent, marking its fifth day of declines for a total drop of about 2 percent.
Rating agency Moody's on Monday changed its outlook for Germany to negative, in part on the potential cost to Berlin if Spain needs more financial help. Moody's also cut the outlook for the Netherlands and Luxembourg to negative from stable.
"It is underlining the fact that whatever resolution for Europe ... will ultimately undermine the stronger members of the euro zone," said Tommy Molloy, chief dealer at FX Solutions in Ridgewood, New Jersey.
U.S. and European manufacturing showed signs of weakness. A stronger factory reading out of China gave commodities support, but the sharp decline in the euro reversed gains in copper and stalled the recent advance in oil prices.
Data showed Europe's economic troubles caused a sharp slowdown in German factory activity, although an improvement in China's manufacturing sector supported oil and copper prices.
U.S. data showed manufacturing expanded at its slowest pace since late 2010, hobbled by weak overseas demand for American goods, though a rise in domestic orders helped cushion the blow.
U.S. Treasuries were steady at higher levels after a 2-year note auction, part of $99 billion in new debt sales planned for this week. The benchmark 10-year note was up 12/32, with the yield at 1.3959 percent after hitting an all-time low of 1.3942 percent.
Three-month copper on the London Metal Exchange fell 0.2 percent after having risen more than 1 percent.
Oil prices fluctuated in choppy trading. Brent dropped 16 cents to $103.10 a barrel and U.S. crude gained 16 cents to trade at $88.30.
(Reporting by Rodrigo Campos; Additional reporting by Chuck Mikolajczak and Gertrude Chavez-Dreyfuss; Editing by James Dalgleish)