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NEW YORK (Reuters) - Stocks took a pounding on Wednesday, although Wall Street managed to pedal back from its steepest lows, and safe-haven government debt prices rose after U.S. and Chinese inflation data fanned worries about a global slowdown.
A key gauge of Wall Street anxiety hit its highest level since November 2011 as investors rushed to buy protection against further losses, and options activity surged as investors reevaluated their strategies in light of the latest signs that the global economy may be losing its footing.
The S&P 500 fell as much as 3 percent, briefly turning negative for the year, while European equities .FTEU3 finished 3.2 percent lower and marked their biggest one-day slide in almost four years.
Popular trades that have worked for most of the year, including heavy bets on the dollar, more gains in stocks, and on an eventual rise in yields, are unraveling.
A fall in China's inflation rate to a five-year low and a decline in U.S. producer prices for the first time in over a year were worrisome signs to investors already skittish about the path of the global economy and caused them to reassess their views on when the U.S. Federal Reserve might hike interest rates.
"There's concern about an absence of aggregate demand in the world, and that's really what's weakening the market. The big fear out right now is we're not immune from that," said David Joy, chief market strategist at Ameriprise Financial in Boston.
"If you look at the lows of the day, maybe we've put in a little bit of a trading bottom here. But I don't think it makes these concerns go away."
The latest news on the spread of Ebola added to a climate of fear, with Texas officials reporting that another healthcare worker in Dallas tested positive for the deadly virus. Almost 4,500 people have died of the disease, mostly in West Africa.
An MSCI gauge of stocks in major markets .MIWD00000PUS was down 1 percent. The CBOE Volatility Index closed at 26.25, up 15.2 percent, after earlier hitting 31.06, the highest level since November 2011.
The Dow Jones industrial average .DJI fell 173.45 points, or 1.06 percent, to 16,141.74, the S&P 500 .SPX lost 15.21 points, or 0.81 percent, to 1,862.49, and the Nasdaq Composite .IXIC dropped 11.85 points, or 0.28 percent, to 4,215.32.
Trading volume in the options market was the busiest of the year, according to Trade Alert data, while equities volume on Wall Street was near 12 billion shares, a nearly 50 percent increase from the average daily volume so far this month.
It was also the heaviest trading day for on-the-run 10-year Treasury note contracts since May 2008.
Flight from risk resulted in a massive rally in U.S. Treasuries, pushing the benchmark 10-year note's yield as low as 1.865 percent, its lowest level since May 2013.
Benchmark yields US10YT=RR retraced a large part of the downward move in late trading, but ended lower on the day, with prices up 22/32 to yield 2.1288 percent, compared with 2.206 percent in late trading on Tuesday.
Ten-year Bund yields DE10YT=TWEB hit a record low of 0.719 percent before edging up to 0.757 percent.
Rate futures now show the market does not expect the Fed to raise rates until early 2016, a dramatic change from a few weeks ago, which could keep downward pressure on yields.
"Everyone's animal spirit is dead. This is a pretty dramatic move when everyone was expecting higher rates," said George Goncalves, head of U.S. interest rates strategy at Nomura Securities International in New York. "It's all about capital preservation at this point. All the crowded trades are being tested, which is why I’m not sure this is over."
The spread of high-yield corporate bond spreads .MERH0A0 over the benchmark U.S. Treasuries, which represents the premium paid to investors to compensate for the risky corporate debt, rose to match the high hit in September 2013, at 483 basis points. The spread had bottomed at 335 bps in June.
A repricing of Fed expectations fueled a selloff in the dollar, which has been rising recently on bets on policy tightening at the Fed while other central banks continue easing.
The soft data "paired with the decline in Treasury yields and declines in energy prices, are all raising concern regarding the timing of the Fed's next move," said Sireen Harajli, currency strategist at Mizuho Corporate Bank in New York.
Although U.S. September retail sales had been expected to decline, the weakness was surprising because it was broad-based.
The euro EUR= rose 1.4 percent against the dollar at $1.2836, just below a three-week high of $1.2885 hit earlier. The greenback lost 1 percent against the yen JPY= at 105.93.
Spot gold prices XAU= rose 0.7 percent, up for the sixth time in the last eight sessions with the help of the weaker dollar, but copper prices CMCU3 tumbled 2.3 percent.
Brent and U.S. crude futures fell, a day after posting their biggest daily drop in years, with more production, less demand and deflation expectations weighing heavily.
Brent LCOc1 lost 2 percent to $83.36 a barrel while U.S. crude fell 1 percent to $81.02.
Emerging markets were also hit with a fall in Russia's rouble RUB= to its weakest level on record, while Russian government 10-year yields hovered near a five-year high, and shares in Moscow .IRTS closed near a seven-month low hit last week.
(This version of the story corrects word in lead to "pedal" from "peddle")
Additional reporting by Chuck Mikolajczak, Sam Forgione, Michael Connor, Richard Leong, Daniel Bases and Yasmeen Abutaleb; Editing by David Gaffen, David Gregorio and Leslie Adler