Dorothy Stang, 74, was shot in the face three times near the town of Anapu, about 1,300 miles north of Sao Paulo in the Amazon region, federal police officer Fernando Raiol said. The early morning attack came less than a week after Stang met Human Rights Secretary Nilmario Miranda to report that four local farmers had received death threats from loggers and landowners.
Last year, loggers accused Stang of inciting violence in the region and supplying weapons and ammunition to local people, a claim her family denies.
"This is extremely serious," Miranda told reporters. "We cannot allow this murder to go unpunished."
The Brazilian government compared the murder with the 1988 killing of Chico Mendes, the renowned rubber tapper who drew international attention to Amazon rainforest destruction.
"It's the type of crime that shows a profound disrespect for a democratic society, like the crime against Chico Mendes," Justice Minister Marcio Thomaz Bastos told the Estado news agency.
The Catholic Church's Land Pastoral in Brazil, an organization that helps landless farmers, condemned the incident as an "assassination."
Stang, a native of Dayton, Ohio, had lived in Brazil since the early 1960s and worked in the region for more than 20 years. She was headed to a meeting with local peasants when her group was attacked, police said. No one else was hurt.
Two suspects have been taken into custody, police said.
Stang's niece Angela Mason, who lives in Dayton, Ohio, said her aunt had told her family there was a price on her head.
"She was basically protected by her status as being an old lady and being a nun. She also recently became a Brazilian citizen, and she thought that would help but it obviously didn't," Mason said.
Brazilian President Luiz Inacio Lula da Silva ordered a thorough investigation into Stang's murder.
About 15 federal officers were immediately dispatched to the crime scene, police said. Miranda and Environment Minister Marina Silva also were sent to Anapu to oversee the investigation.
Stang was a member of the Congregation of the Sisters of Notre Dame de Namur, an international Catholic religious order of about 2,000 women in five continents.
Last June, Stang was honored by the state of Para for her work in the Amazon region. In December, she received an award from the Brazilian Bar Association for her work helping the local rural workers.
"She was awesome. A little old bundle of joy," Mason said. "She was the happiest person. She needed nothing. She just loved the people down there."