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Monday's rally lost momentum on a report a major ratings company may put Germany, France and four other euro zone countries on warning for a futures downgrade.
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As of 2:20 p.m. ET, the Dow Jones Industrial Average rose 73.8 points, or 0.61%, to 12,093, the S&P 500 gained 12.3 points, or 0.99%, to 1,257 and the Nasdaq Composite jumped 27.1 points, or 1%, to 2,654.
With the docket of U.S. economic data fairly shallow on Monday, traders will be paying close attention to Europe, where leaders are rushing to put together a comprehensive package to save the euro.
The Financial Times reported Standard & Poor's plans on putting Germany, France, the Netherlands, Austria, Finland, and Luxembourg on so-called "creditwatch negative." That would imply there is a 50/50 chance the ratings company will downgrade the triple-A rated countries within the next 90 days, according to the paper. The move may come as early as Monday, the report said.
Also on that front, German Chancellor Angela Merkel and French President Nicholas Sarkozy met in Paris on the day ahead of a key summit later in the week. The leaders of Europe's two biggest economies said they would like to create a treaty that forces countries to keep their fiscal houses or face sanctions if they fail. The heads of state also said they would prefer all of the European Union countries to agree to the measures, but would accept agreement by just countries in the smaller euro zone.
Investors are expecting European leaders to "come out with big guns blazing," Louise Cooper, a market analyst with BGC Partners, said in an interview with FOX Business, adding that they expect a "big" announcement following summit.
The hope is that if European officials create a system to make sure countries are keeping their debt inline, it will give the European Central Bank the ammunition it needs to launch a large bond-buying program to ease yields on embattled euro-zone sovereign debt.
The European Central Bank is the only institution that has the power to create euros, and is widely seen as a crucial player in tackling the crisis. The problem is the ECB doesn't want to increase the likelihood of repeating the crisis by bailing the system out without consequences for highly-indebted countries.
To that end, Italy's new government unveiled a roughly $40 billion austerity program on Monday that includes spending cuts, tax increases and reforms to the country's costly pension system. Italy is Europe's third-biggest economy, and has an enormous public debt burden. The specter that it may need a rescue like other heavily-indebted countries spooked the markets several weeks ago, and forced the ouster of its old government.
The country's 10-year bonds yield 6.35% presently, or trade at a 4.18 percentage-point premium to Europe's safe-haven German bund. That represents a considerable easing from just a week ago when yields topped the closely-watched 7% mark.
European blue chips jumped 1.6%, while the euro fell 0.26% to $1.3449.
Financial shares performed the best in mid-session trading, with big banks such as JPMorgan Chase (NYSE:JPM) and large investment banks like Morgan Stanley (NYSE:MS) zooming higher. Energy shares, such as Schlumberger (NYSE:SLB), posted solid gains a swell.
In contrast, consumer staples like Kraft Foods (NYSE:KFT) and Wal-Mart (NYSE:WMT) struggled. Market participants have sold U.S. Treasury bonds as they have moved into equities, pushing yields higher. The benchmark 10-year note yields 2.093% from 2.037%.
The markets posted a blockbuster performance last week: the broad S&P 500 surged 7.4%, while the blue chips tacked on some 788 points.
On the U.S. front, data released on Monday showed factory orders fell by 0.4% in October from the month prior, slightly more than the 0.3% fall economists' anticipated. Excluding the transportation component, orders were up 0.2% on the month.
Meanwhile, a separate report showed the services sector expanded at a slower pace than expected last month. The Institute for Supply Management's gauge of the non-manufacturing sector fell slightly to 52 from 52.9 the month prior. Economists has forecast a reading of 53.5. Readings above the 50 mark point to expansion, while those below indicate contraction.
Energy markets were mixed. The benchmark crude oil contract traded in New York fell 12 cents, or 0.14%, to $100.83 a barrel. Wholesale RBOB gasoline climbed 1 cent, or 0.26%, to $2.63 a gallon.
European blue chips jumped 1.6%, the English FTSE 100 climbed 0.83% to 5,598 and the German DAX rallied 1% to 6,141.
In Asia, the Japanese Nikkei 225 rose 0.6% to 8,696 and the Chinese Hang Seng gained 0.73% to 19,180.