LONDON — Market relief over a U.S. agreement to raise the country's debt ceiling proved short-lived on Monday after a downbeat survey stoked fears that the world's largest economy may be sliding back into recession.
Following last week's figures showing that the U.S. economy grew by an annualized rate of only 1.3 percent in the second quarter, worrying signs emerged Monday indicating that tepid growth may be faltering.
The closely-watched manufacturing survey from the Institute for Supply Management was particularly disappointing. The headline index for July dropped to 50.9 from the previous month's 55.3.
The scale of the decline was unexpected and has raised concerns that the manufacturing sector is heading towards recession. Any reading below 50 indicates that the sector is contracting.
Analysts said the survey was evidence that the difficulty to agree on raising the debt ceiling has hurt the real economy by making businesses more reluctant to invest.
"This is why it was so important to come to an agreement earlier, and to have a more credible plan to avoid a downgrade and/or default," said Jennifer Lee, a senior economist at BMO Capital Markets. "The ISM report is the first figure we have for the second half and it has not set a good tone."
The grim report from ISM has come at the start of a week that could be crucial in investors' perceptions of the U.S. economy. A raft of economic data culminates on Friday with the nonfarm payrolls report. At the moment, the consensus is that the U.S. economy generated only 100,000 jobs during July, which would not be enough to reduce the unemployment rate.
Following the data, U.S. and European markets shed their earlier gains.
In Europe, the FTSE 100 index of leading British shares closed down 0.7 percent at 5,774.43 while Germany's DAX nosedived 2.9 percent to 6,953.98. The CAC-40 in France ended 2.3 percent lower at 3,588.05.
On Wall Street, the Dow Jones industrial average was down 1.0 percent at 12,024.53 while the broader Standard & Poor's 500 index fell 1.1 percent to 1,278.26.
Stocks in the U.S. had opened higher, echoing the gains seen in Europe and Asia, as investors breathed a sigh of relief that U.S. lawmakers appeared to have agreed to a last-minute deal to raise the U.S. debt ceiling, preventing the world's largest economy from defaulting.
President Barack Obama said Republican and Democratic leaders thrashed out the details of a deal that would cut more than $2 trillion of federal spending over the next decade and avoid a potentially devastating default.
The agreement has to be voted for by both houses in Congress, though no votes are anticipated Monday.
Investors have watched the political brinkmanship over the past couple of weeks with increasing anxiety. The specter of a debt default had weighed on markets in recent weeks, sending stocks sharply lower.
Though a debt default appears to have been avoided, worries over U.S. finances are likely to persist and a number of analysts think the credit rating agencies may still downgrade the country's triple A rating.
Lee Hardman, a currency economist at The Bank of Tokyo-Mitsubishi UFJ, said the dollar is likely to "come under increasing selling pressures in the weeks ahead in anticipation of a downgrade."
However, while stocks were in retreat, the dollar pushed sharply higher against the euro after the ISM data, as it garnered support from its status as a safe haven for investors.
By late afternoon London time, the euro was 1.1 percent lower on the day at $1.4205.
The dollar also fell to a record low of 76.27 yen, according to data provided by FactSet, after the ISM figures but has recovered some ground and was trading at 76.83 yen. In March, the world's leading central banks intervened to lower the yen when the dollar had fallen to a low of 76.32 yen in the wake of Japan's devastating earthquake and tsunami.
A slowdown in the U.S. is not the only economic concern occupying investors' minds at the moment. Equivalent manufacturing surveys for the eurozone, Britain and China also indicated growth was slowing.
China is a particular concern, as its growth has helped support the world economy in the past few years.
Chinese shares underperformed their counterparts in Asia after HSBC's purchasing managers' index fell to its lowest level in 16 months and showed manufacturing activity contracting. A survey by an industry group, the China Federation of Logistics and Purchasing, showed activity expanding, but only slightly.
China's main index in Shanghai rose only 0.1 percent to 2,703.78.
Japan's Nikkei 225 stock average closed up 1.3 percent at 9,965.01 and South Korea's Kospi gained 1.8 percent to 2,172.31. Hong Kong's Hang Seng added 1 percent to 22,663.37 and China's Shanghai Composite Index rose 0.1 percent to 2,703.78.
Oil prices followed stock markets lower. Benchmark oil for September delivery was down 61 cents to $95.09 a barrel in electronic trading on the New York Mercantile Exchange.
Alex Kennedy in Singapore contributed to this report.