Volkswacht Bodensee - Markets drop as US downgrade jolts latest rally

However, high hopes that the Federal Reserve was at or near the end of its interest rate hiking cycle and a still-resilient economy meant the mood on trading floors remained broadly upbeat, analysts said.

Investors shifted away from riskier investments after Fitch cut the US debt rating by one notch from its AAA level, citing a growing federal debt burden and an "erosion of governance" that has manifested in debt limit standoffs.

The move follows a long, drawn-out row between Republicans and Democrats earlier this year over raising the US borrowing ceiling, which had fuelled fears of a devastating default by the world's top economy.

While a deal was eventually struck, the saga rattled markets and reinforced the sense of long-running deadlock on Capitol Hill that has seen the gears of government jammed up.

Though the lifting of the US debt ceiling -- a limit on government borrowing to pay for bills already incurred -- was once routine, it has for several years become a contentious partisan issue.

The downgrade is the first by a major ratings company since a similar debt impasse in 2011 saw S&P lower its top-notch classification.

White House press secretary Karine Jean-Pierre said the move "defies reality", while Treasury Secretary Janet Yellen said in a statement that she "strongly" disagreed with Fitch, calling the change "arbitrary and based on outdated data".

The announcement meant it would be more expensive for the government to borrow. However, the risk-off sentiment sent traders rushing to safe assets, such as Treasuries, as well as the yen.

Chang Wei Liang, at DBS Bank, said: "High inflation and growth remain the key triggers for Treasury selling, with credit ratings shifts largely mitigated by the substantial stock of US private wealth, and a correspondingly large safe haven demand for US Treasuries."

Earlier, all three main Wall Street indexes had dropped after news that US factory activity shrunk in July for the ninth consecutive month, hinting at softness in the economy.

Profit-taking added to the selling following a recent run-up fuelled by optimism that the Fed's rate hike last week would be its last thanks to an easing of inflation pressure.

Hong Kong took a heavy hit after more than a week of strong gains, with tech firms taking the brunt of the selling as China set out rules to curtail the length of time children spend on their smartphones.

That added to lingering worries about the Chinese economy, even after a series of pledges to kickstart growth.

Shanghai was also well off, while Tokyo, Singapore, Mumbai, Seoul, Sydney, Taipei, Manila, Bangkok and Jakarta were also deep in the red.

London, Paris and Frankfurt sank at the open.

Still, SPI Asset Management's Stephen Innes said the outlook was positive.

"While debt downgrades seldom, if ever, have long legs, investors may pause and let the dust settle before re-entering risk markets," he said in a note.

"However, within this super market-friendly environment of stable growth and a Fed close to the end of its hiking cycle creating fertile ground for stock gains, it's unlikely risk sentiment will wander too far off the soft landing path."

And Joshua Crabb, at Robeco Hong Kong, added: "The market had a really good run in recent sessions. It's just looking for something to get worried about."

Oil prices, meanwhile, surged about one percent after the American Petroleum Institute said US stockpiles plunged last week, sparking worries about supplies.

- Key figures around 0715 GMT -

Tokyo - Nikkei 225: DOWN 2.3 percent at 32,707.69 (close)

Hong Kong - Hang Seng Index: DOWN 2.4 percent at 19,524.84

Shanghai - Composite: DOWN 0.9 percent at 3,261.69 (close)

London - FTSE 100: DOWN 0.9 percent at 7,598.26

Euro/dollar: UP at $1.0992 from $1.0985 on Tuesday

Pound/dollar: DOWN at $1.2772 from $1.2776

Euro/pound: UP at 86.05 from 85.96 pence

Dollar/yen: DOWN at 142.65 yen from 143.34 yen

West Texas Intermediate: UP 1.0 percent at $82.17 per barrel

Brent North Sea crude: UP 1.0 percent at $85.73 per barrel

New York - Dow: UP 0.2 percent at 35,630.68 (close)

-- Bloomberg News contributed to this story --

O.Bulka--BTB