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S&P downgrades Italy. S&P cut Italy's credit rating to A from A+, with outlook negative, citing the political situation as limiting the nation's ability to respond effectively to its debt crisis. S&P said the negative outlook "reflects our view of additional downside risks to public finances related to the trajectory of Italy's real and nominal GDP growth." Italy's FTSE MIB is -3.2% this morning and the euro is -0.4% against the dollar (1:30 ET).

How much austerity? Greek Prime Minister George Papandreou is considering holding a referendum on whether to stay the austerity course or exit the euro. Sources say Papandreou feels like his government needs a mandate to continue pushing ahead with reforms, and some in his cabinet are pressing for drastic measures. Greece has denied the report. Meanwhile, new calculations show more of the U.K.'s deficit isn't caused by a slow economy but is instead permanent, raising estimates of the structural deficit by £12B, or 25%. U.K. officials are holding "agonized discussions" on whether to add to austerity measures to account for this new reality.

Japan acts on strong yen. Japan released an interim plan to deal with the strong yen, saying it will move to shore up its economy through such measures as a corporate tax cut and support for small and medium-sized businesses. The government didn't close the door on the possibility of direct currency intervention, saying it remains ready to take "decisive" action as needed.

Transatlantic turns to Validus. Reinsurer Transatlantic Holdings (TRH) is reportedly exploring a "limited standstill" agreement with Validus Holdings (VR), after rejecting a reinstated $3.25B all-cash offer from Buffett's National Indemnity (BRK.A) and calling off a planned merger with Allied World Assurance (AWH). Validus has a hostile cash-and-stock offer on the table for Transatlantic, valued at around $2.9B as of yesterday, but would almost certainly need to raise its bid in order to close a deal.

SEC probes pre-downgrade trades. Sources say the SEC is investigating whether certain hedge funds and other financial firms used inside information to place trades ahead of the S&P's downgrade of the U.S. credit rating. Regulators have issued unusually broad subpoenas trying to establish why certain trades were made, but the SEC will likely have a hard time putting together a case as there was an abundance of bad global news that could have prompted bearish trades at the time.

UBS's rogue trades prompt legislative response. Following UBS's (UBS) $2.3B loss from rogue trading, some Swiss legislators are pushing for a ban on risky investment banking and increased capital requirements. In the U.K., regulators are putting more pressure on banks to evaluate their compliance and controls systems, while the rogue trader's possible exploitation of an ETF trade reporting loophole could speed up efforts by the European Commission to create more transparency about the European ETF market. As for UBS itself, it appears that none of the senior management will lose their jobs over the debacle, but the firm will likely accelerate its overhaul plans.

Offshore scrutiny grows. The Justice Department disclosed that eight offshore banks are under federal grand jury investigation for helping U.S. citizens avoid taxes. The number of banks under investigation hadn't previously been disclosed, and the announcement at this time suggests the government's enforcement efforts may be further along than previously believed.

SEC proposes limits on firms' bets. The SEC released a proposal yesterday designed to prevent financial firms from betting against packaged financial products sold to clients. The proposal is open for public comment, and includes exemptions such as when a firm is hedging its risk.

ConAgra drops Ralcorp bid. ConAgra (CAG) formally withdrew its $5.2B all-cash offer for Ralcorp (RAH) after repeated rejections. The $94/share offer is a higher price than Ralcorp has ever traded, but the company decided the bid would generate less value than current plans to spin off Post Foods.

Jazz Pharma merges with Azur Pharma. Jazz Pharmaceuticals (JAZZ) announced it will merge with Ireland's Azur Pharma in an all-stock deal. Like Jazz, Azur develops drugs for treating women's health and central nervous system issues. The combined company will have $475M+ in revenue and $200M+ in cash flow in its first 12 months. Jazz fell 4.6% in AH trading.

Today's Markets
Asia: Japan -1.6%. Hong Kong +0.5%. China +0.4%. India +2.3%.
Europe at midday: London +1.5%. Paris +1.5%. Frankfurt +2.3%.
Futures at 7:00: S&P +0.66%. 10-yr -0.08%. Euro -0.02% vs. dollar. Crude +1.07% to $86.72. Gold +0.51% to $1785.85.

Tuesday's Economic Calendar
FOMC Meeting, Day 1
7:45 ICSC Retail Store Sales
8:30 Housing Starts
8:55 Redbook Chain Store Sales

Notable earnings before Tuesday's open: AZO, CAG, CCL, JEF

Notable earnings after Tuesday's close: ADBE, ORCL

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Source: Wall Street Breakfast: Must-Know News