Global stocks and the euro cut gains on Monday as a report that six euro zone countries faced a warning over a possible downgrade offset optimism that policymakers could reach a credible solution to the sovereign debt crisis.
Standard & Poor's has warned Germany, France and four other AAA-rated euro zone countries that they might get downgraded in the next 90 days, the Financial Times reported.
U.S. stocks gave up some gains, while the euro reversed its advance against the U.S. dollar to hit a session low. The euro traded as low as $1.3384 on Reuters data. It was last at $1.3389, down 0.1 percent on the day.
The report highlighted the uncertainty surrounding the debt crisis even as French President Nicolas Sarkozy and German Chancellor Angela Merkel agreed on a master plan for imposing budget discipline across the region, saying the EU treaty will need to be changed.
The leaders said their proposal included automatic penalties for governments that fail to keep their deficits under control, and an early launch of a permanent bailout fund for euro states in distress.
Wall Street was up nearly 1 percent in midday trading, while world stocks as measured by MSCI were up 0.7 percent, off earlier highs.
The proposal will be sent to EU officials on Wednesday, ahead of a summit on Friday. European stocks hit a five-week closing high, though analysts were wary the optimism could prove overdone.
We are far from an easy consensus that it's a done deal, said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co in San Francisco. But we are further along in the negotiations than we've been and we are focused on the right things now.
The Dow Jones industrial average <.DJI> was up 57.97 points, or 0.48 percent, at 12,077.39. The Standard & Poor's 500 Index <.SPX> rose 10.91 points, or 0.88 percent, to 1,255.19. The Nasdaq Composite Index <.IXIC> gained 26.55 points, or 1.01 percent, to 2,653.48.
There were signs not everyone was convinced of a positive outcome in Europe. Interbank dollar borrowing costs inched up as uncertainty over policymakers' ability to contain the crisis made banks wary of lending to each other.
Investors are hoping the agreement will pave the way for the European Central Bank to buy large amounts of government bonds to try to stop the crisis from spreading.
Deep austerity measures from Italy assuaged investor fears and sent Italian bond yields further below the worrying 7 percent level.
Italian Prime Minister Mario Monti presented a 30-billion-euro (25.7-billion-pound) austerity package to parliament, saying the country risked a Greek-style economic collapse without it.
Ten-year Italian government bond yields slumped 72 basis points to 6.03 percent -- its lowest in a month.
But Monday's data highlighted the precarious world economic situation. Purchasing manager surveys for November showed the euro zone's economy may be shrinking more quickly than previously thought, while growth in China's services sector sagged to a 3-month low.
While the U.S. economy is still expected to avoid another recession, the day's data was also downbeat, with growth in the services sector slowing in November, and new orders declining in October for a second straight month.
This is the first disappointing indicator we've seen in the last couple of weeks, Cary Leahey, managing director at Decision Economics in New York, said of the U.S. data.
The economy has improved, it is still not growing very quickly.
The week ahead features a series of high-profile meetings among European leaders seen as crucial to the future of the 17-nation euro zone.
On Tuesday, U.S. Treasury Secretary Timothy Geithner kicks off a visit to the region in Germany, where he will meet European Central Bank President Mario Draghi and government officials.
(Additional reporting by Richard Hubbard in London, Edward Krudy in New York; Editing by Dan Grebler)