NEW YORK (Reuters) - U.S. stocks fell more than 1 percent on Thursday after comments from U.S. Senate Majority Leader Harry Reid that the United States may be poised to go off the "fiscal cliff," while the yen hit a two-year low on expectations of aggressive monetary stimulus.
Democrat Reid criticized Republicans for refusing to go along with any tax increases as part of a U.S. budget remedy and said the economy seemed to be heading over the fiscal cliff of impending tax hikes and spending cuts.
Economists warn that the $600 billion in higher taxes and spending cuts set to kick in from January could push the world's largest economy into recession, dragging other countries with it.
For weeks, markets have been driven by any new information on the status of the fiscal cliff talks. All three major U.S. stock indexes fell more than 1 percent after Reid's comments and world stocks also were driven lower.
On Wall Street, the Dow Jones industrial average .DJI was down 132.98 points, or 1.01 percent, at 12,981.61. The Standard & Poor's 500 Index .SPX was down 15.23 points, or 1.07 percent, at 1,404.60. The Nasdaq Composite Index .IXIC was down 31.96 points, or 1.07 percent, at 2,958.19.
Shares of U.S. retailers fell for a second day following the Christmas holiday. The Morgan Stanley retail index .MVR was down 1.4 percent while the SPDR S&P Retail Trust (XRT.P) lost 1.1 percent.
The MSCI global index .MIWD00000PUS was last down 0.4 percent, while European shares .FTEU3 ended down 0.04 percent.
Frank Lesh, a futures analyst and broker at Futurepath Trading in Chicago, said his clients have been delaying trading due to uncertainty about the negotiations' outcome, making the year-end period quieter than usual.
"With the added drama in Washington, we have got even more people sidelined," he said. "No one knows how this turns out or how the markets are going to react to it."
U.S. President Barack Obama is traveling back to Washington on Thursday, cutting short his holiday to try to get a budget deal with Republican lawmakers.
Asset performance in 2012: link.reuters.com/muc46s
Fiscal cliff woes impact: link.reuters.com/num84t
EURO DIPS, YEN SLUMPS
The dollar rose to 85.92 yen, its highest since August 2010. It was last up 0.4 percent on the day at 85.91 yen with option barriers cited at 86 yen and stop-loss buy orders above 86.10 yen.
Investors accelerated their yen sales after Japanese Prime Minister Shinzo Abe said his newly formed government would pursue a bold monetary policy, a flexible fiscal policy and a growth strategy to encourage private investment.
The yen has fallen roughly 10.5 percent versus the dollar in 2012, its biggest annual drop since 2005. At the same time, Japan's benchmark Nikkei is now up 22 percent for the year.
"Yen weakness, based on expectations that the new Japanese government will succeed in driving the dollar to 90 yen with a combination of more aggressive monetary and fiscal policy, is offering support to other currencies," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York.
The euro traded at $1.3216, down slightly for the day and below an eight-month high of $1.3308 hit last week.
The euro tends to benefit when U.S. budget negotiations run smoothly, but when there are snags, investor flows go into the safe-haven and highly liquid dollar.
U.S. BONDS TRADE HIGHER, OIL EASES
Prices on longer-dated U.S. Treasuries were higher. The bond market began trimming its decline earlier on data that showed a bigger-than-expected drop in American consumer confidence in December, spurring worries about flagging consumer spending causing a U.S. recession.
Benchmark 10-year Treasuries prices were 12/32 higher in price, yielding 1.7077 percent, compared with being down by 2/32 before the confidence data and Reid's remarks.
Oil prices eased in choppy trading as the unresolved U.S. budget left open the possibility that looming mandated tax hikes and spending cuts could push the economy of the No. 1 oil consuming nation into recession.
Brent February fell 41 cents to $110.66 a barrel, while U.S. February crude was down 26 cents at $90.72.
(Additional reporting by Gertrude Chavez-Dreyfuss, Robert Gibbons, Richard Leong and Edward Krudy in New York; Editing by Chizu Nomiyama and Dan Grebler)