As Americans give thanks over the holiday table Thursday, nervous traders will be watching the developments overseas and will continue to do so in Friday's half day stock market session.
There are no U.S. economic reports of note Friday, so Europe will dominate. On Thursday, German Chancellor Angela Merkel and French President Nicolas Sarkozy meet with newly named Italian Prime Minister Mario Monti.
"I don't see any magic coming out of it," said Art Cashin, director of floor operations at UBS. "The problem is they don't have a plan. This is like a town that has no fire department. When something catches ablaze, we're all in it together."
Traders spent Wednesday dodging headlines from Europe, as they do most days lately. But particularly worrisome was news of a failed German bund auction, which while not the first was the most substantial and visible at a time of nervousness in markets. Germany offered 6 billion euros in slightly more than 10-year bunds, but received offers for just 3.9 billion euros. The news followed a disappointing PMI manufacturing report from China, which showed contraction and the weakest activity in 32 months. German PMI data Wednesday also signaled economic contraction.
"People have been talking all week about what we are going to do about Thanksgiving because you don't know how to protect yourself (when U.S. markets are closed), because everything is so correlated. They're trying to keep positions as flat as they can. We got more hit than Europe (stock markets Wednesday) because it was possibly people raising money early in the day. Commodities were heavy hit, as were stocks," Cashin said.
The Dow fell 2 percent Wednesday to 11,257, and the S&P 500 was off 2.2 percent at 1,161. Stocks are closed all day Thursday, and close at 1 p.m. after a shortened session Friday. The bond market is closed Friday, but oil and other futures are trading.
The euro fell 1.2 percent to 1.334 Wednesday, the lowest level since Oct. 3. Goldman Sachs analysts early in the day had reversed their view that investors should be long euros based on the idea that the "technocrat" governments in Italy and Greece could help reduce risk aversion. They also said the currency was at risk because of weaker global cyclical indicators, such as the Philly Fed index and Wednesday's Chinese PMI report.
Investors have been wondering where is the feasible plan from European leaders that will stop contagion. Yields flamed higher on sovereign bonds across the continent Wednesday, as investors saw no solution in sight.
"I think a lot of people are talking about this failed German auction today as more evidence that the core is being contaminated by what's affecting the periphery. I think people were misreading the tea leaves. This is the sixth of the last eight that were undersubscribed," said Marc Chandler, chief currency strategist with Brown Brothers Harriman. But Chandler added that the auction was more undersubscribed than the others, and some traders say it was the weakest since the mid 1990s, a disturbing signal of concern about the health of the euro zone.
Chandler said the negative manufacturing data from China hung over markets and was the first catalyst for Wednesday's downward spiral, but there was also industrial orders in the euro zone that were not as robust as expected. "I think the euro is going down," he said. We've got the euro finishing the year at 1.29."
Robert Sinche, head of global currency strategy at RBS, said the German auction was a factor, but made worse by the concern that China is slowing. "There's no way to paint this as a constructive outcome in this environment, but I think in this environment it's probably getting a lot more emphasis than it deserves, and I think it would not have been as poorly perceived were it not for the weak Chinese PMI estimate. It's coming into a market that has a lot of things to worry about and just when you have a couple of days of calm in Europe, you have something the markets jumped all over again. It reinforced the sentiment that there's not a strong anchor anywhere to rely on," he said.
The European Commission Wednesday released details of a new plan for oversight authority of European Union fiscal policies. The commission made new proposals Wednesday to take further power over member states.
Commission vice president for economic and monetary affairs Olli Rehn said member states must quickly implement the agreed reforms as the situation in financial markets is "extremely worrying."
Proposals include new rules to ensure country budgets do not break EU rules. If accepted, the rules would require the euro zone governments send the commission draft budgets before they are approved by national parliaments. Countries would also have to set up independent councils to evaluate fiscal policy and use independent economic forecasts for budgets. A country could also be formally asked to apply for aid if the European Central Bank believes it should.
The Commission also discussed joint debt issuance, which is strongly opposed by Germany and drew comments from Merkel Wednesday.
"I think what people are ignoring is the other side of the tail risk... It's what German is pushing for. What the EU is pushing for — unity. The ECB should buy more bonds. What's the quid pro quo? The exchange is giving up more fiscal authority. That is having the EU being able to sue countries for not living up to their agreements," Chandler said.
Sinche said it may be that Germany is posturing for a reason. "The question is whether in the final analysis Germany will relent on some of these things that many in the market think are necessary to get through the crisis. More aggregate European debt issuance... how that's structured? We don't' know. Broader market support for them through the ECB perhaps, working through an intermediary?... Are they really against all that regardless of the implications? Or, are they negotiating the best set of conditions around those developments that they possibly can," Sinche said.
He said one issue is whether the private sector or the sovereigns take responsibility. "How much of this adjustment should be born by Germany and how much by the private sector which has been involved in these markets for decades. The extent to which some entities are going in and buying existing debt, I can see a real problem in that you're not really helping countries that need to issue new debt. You're basically helping bail out the private sector from bad positions, " he said.
Chandler said that debate is at the heart of the crisis. "I think there's a very tight relationship between the sovereign and the bank debt. It's like the monster we are fighting is like a hydra. It has has a couple of heads but it's the same animal. The problem is investor confidence in the banks and sovereigns, and the problem they both have is deleveraging. By stabilizing the sovereigns, they'll stabilize the banks," he said.
The markets are watching the Dec. 9 EU leaders meeting as a next deadline for developments, but Sinche said the biggest development to watch is whether Greece takes the required steps to get the funding it needs. "If Greece doesn't get funded, they'll default before year end. There's a December 9 meeting and I think there'll be a lot of excitement and anticipation, but Greece has 20 days of cash left," he said.
Chandler isn't as discouraged as some who think there is no movement in Europe and little chance for it. "I think we're moving ahead, but it's like it's stuttering and reluctantly. I'm not sure the crisis is of yet a severe enough nature to get them over these ideological hurdles but I think we're moving in the right direction."
Follow Patti Domm on Twitter: @pattidomm