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European Leaders Drive Investors Down a Bumpy Road

Investors will follow every move from European leaders on the road to Friday's EU summit, and financial markets will feel every bump along the way.

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That certainly was the case Monday when the Dow was up as much as 167 points but gave back half of those gains, after reports that Standard & Poor's could put the members of the euro zone on credit watch for possible downgrade. Standard & Poor's, after the close, did say it was putting 15 countries, including Germany, on credit watch because of tightening credit conditions, the risk of recession , high debt levels and continued disagreement among European officials about how to tackle their sovereign crisis .

"We've got four days to go before we know truly what is achieved in Brussels on Friday. I would be buying the dip because I think we've got the basis for a clear achievement on Friday. The market is going to be extremely susceptible of any headlines of this quality but at the end of the day, I think Europe might have something," said Paul Richards, UBS head of foreign exchange distribution, Americas.

Richards, on "Closing Bell," also said the bigger deal for markets Monday was the meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy. Merkel and Sarkozy announced intentions to change the EU treaty to allow for a tighter fiscal unity and oversight. After the S&P announcement, they again commented, saying their European partners are united in their efforts to take measures needed for euro zone stability. Richards also said a positive outcome this week would be good for stocks and peripheral bonds.

Some analysts said the S&P comments might be positive in that they may push European countries to generate a plan more quickly.

"I think the big news is Merkel and Sarkozy. These two have to find a fiscal agreement. If they truly found one today and convince the EU on Friday that they've got one that allows the ECB (European Central Bank) to potentially get that big thing called the bazooka out and start buying a lot of peripheral bonds. This is what the market wants," he said. Richards said that type of agreement would spark a rally in EU peripheral bonds and the ECB could start buying as early as next week.

"We're still, in a way, waiting for the December 9 meeting to see what's going to come out," said Alan Ruskin, head of G-10 foreign exchange strategy at Deutsche Bank. "In terms of Merkel and Sarkozy, it still seems like there's a lot of details to be fleshed out. It didn't leave the market with a sense that there's a complete deal that was on the table and it's ready to be fashioned." Ruskin said more than the ratings agency, European leaders need to convince the ECB that they are going to be fiscally responsible before it will agree to measures that could mean expanding its balance sheet.

The Bundesbank opposes bond purchases but some reports Monday suggested Merkel might overrule its opposition given the right outcome this week.

Ruskin said he also expects to hear more about the IMF and talk that it could take funds from individual nations' central banks to disburse for the euro zone crisis. "It seems like it's circumventing rules. It might be the fastest way, or the only way to do it without breaking certain rules," said Ruskin.

There's no U.S. economic data Tuesday, so markets will remain fixed on Europe. U.S. Treasury Secretary Timothy Geithner meets with ECB President Mario Draghi and Bundesbank President Jens Weidmann in Frankfurt. He later goes to Berlin to meet German Finance Minster Wolfgang Schauble. Geithner and Schauble will comment to the press at about 12 p.m. EST.

The Dow ended Monday, up 78 at 12,097, and the S&P 500 was up 12 at 1,257. The 10-year yield was at 2.052 percent, off its high yield of the day. European sovereigns saw their yields move lower, but those markets closed ahead of the first news reports on the S&P credit warnings. The Italian 10-year, above 7 percent last week, was as low as 5.949 percent before moving back above 6 percent Monday on news of a new Italian budget plan and austerity measures. The euro was at about 1.339 in late trading. Oil, also sensitive to the euro zone news, fell from a high above $102 during the trading day, to a level of $100.55 in late trading.

Barry Knapp, head of portfolio strategy at Barclays, said if the European story has a positive resolution this week, the stock market could go a little higher into year end. "Our year end target was 1,260. I wouldn't be surprised if we didn't push it a little further. That also supposes that we break the problem of (European leaders) over promising and under delivering, and everything comes out great."

But Knapp, who released his 2012 forecast, doesn't expect a positive outcome for stocks early in the year. His first half target is 1,150 but he expects stocks could reach 1,330 by year end. Knapp said he expects uncertainty around public and financial sector deleveraging to influence the market. He still expects 6 percent earnings growth next year.

Follow Patti Domm on Twitter: @pattidomm

Disclaimer

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.