By Greg Peel

The Dow closed up 7 points while the S&P lost 0.2% to 1202 and the Nasdaq fell 0.9%.

I'm not going to labour the point. Yesterday's credit rating downgrade of Italy by Standard & Poor's could hardly be called a shock albeit S&P's previous rating was already below that of Moody's and Fitch. One thus assumes the other agencies will be responding soon to S&P's move to A from A+ (with a negative watch) and we can do it all again.

S&P's reasons for downgrading Italy nevertheless highlight a fundamental problem with the response to date to the European sovereign debt crisis. Aside from political instability ? most European governments understandably have that problem at present although Berlusconi is clearly a standout nutter ? S&P cited a weaker outlook for economic growth in Italy brought about by austerity measured being implemented in order to alleviate the debt problem.

It's a slippery slope. The ECB-EU-IMF troika is forcing austerity upon all the teetering eurozone members which might reduce debt but also reduces the capacity to repay debt. The ratings agencies then do the bleeding obvious in downgrading credit ratings based on that repayment hindrance. Bond markets subsequently sell down that debt, raising the cost of refinancing for the sovereign, which in turn negates the effect of those austerity measures applied in the first place. Stricter austerity measures then need to be applied and doe-see-doe your partner.

Bond markets haven't already sold Italy's debt down to junk status, as they might otherwise have done by now, because the ECB has been in there buying in order to prop Italy up. Yet despite these purchases, yields keep ticking higher. How long can the ECB keep it up?

Stricter austerity measures are the focus in Greece at the moment, where the world's longest telephone call has ended without resolution. The hook-up between the troika and the Greek prime minister began on Monday night, had to be carried over to last night, and finally ended with the troika saying they will be back in early October instead to assess progress. Papandreou had been hoping to calm his people with an announcement that the E8bn tranche of bail-out funds was in the bag but now he has to wait another couple of weeks.

Already Papandreou has contemplated holding a referendum in Greece to ask the people whether or not they want to exit the eurozone altogether. One assumes it's a "put up or shut up" move ahead of riots which will inevitably occur once the Greek government outlines the new set of far stricter austerity measures required to get that E8bn, which will include significant public sector job losses. If the answer is "no", then Papandreou has a clear mandate. If it is "yes" then a snap election would have to be held which the government would likely lose, and then it's no longer Papandreou's problem.

Of course there is no exit clause within the eurozone rules. Greece may not even be allowed to leave. The whole issue yet again raises the question of why this insistence on propping up sovereigns when the real danger lies with a collapse of the banks? Prop up the banks, as the US did in 2008, and it won't matter who goes down. The longer it takes to arrive at this decision, the more dire the situation becomes. Europe is losing the battle.

Wall Street took the Italy downgrade in its stride from the open last night, and an inevitable trimming of the IMF's global economic growth forecast, and also shook off a 5% fall in August housing starts. Aside from the "knock me down with a feather" aspect of the downgrade and the IMF cut, Wall Street is looking with anticipation towards tonight when for some reason it expects Ben Bernanke to save the world. Never mind that no one expects QE3, only a so-called "Operation Twist" in which short-end Fed Treasury holdings are exchanged for long-end Treasuries.

Such a strategy is really the QE you have when you're not having a QE. Long bonds are purchased with the same intention a central bank would have in providing monetary stimulus, but rather than expanding its balance sheet the central bank is effectively just rolling previous QE further out in time. Given the US ten-year bond yield is already around its all-time low, many commentators are at a loss as to what such a strategy might achieve, and they certainly can't see how the dots can be connected from "twist" to job creation, which after all is the end result objective.

Anyway, we'll have to wait to tomorrow morning to find out.

Wall Street rallied to be up 150 points by mid-afternoon but then began to lose steam. When the news that the Greek bail-out tranche decision had been postponed hit the wires, the sellers moved in in earnest. The saga continues.

Commodity markets closed when Wall Street was at its highs so base metals were mixed and Brent rose US$1.40 to US$110.54/bbl. West Texas gained US$1.19 to US$86.89/bbl.

Gold was stronger all session, whether through Europe fears or anticipated QE of some sort, and is up US$26.30 to US$1804.80/oz. The US dollar index is down slightly at 76.97 and the Aussie is up 0.4% to US$1.0264.

In a repeat of last week when French banks saw their ratings downgraded and the Australian market panicked unnecessarily, yesterday's overreaction by comparison to last night's move on Wall Street means the SPI Overnight is up 33 points or 0.8%.

Ahead of the Fed policy statement tonight the RBA's deputy governor will be making a speech today. Ric Battelino can often be a bit more forthcoming than his boss so it will be interesting to hear what he might have to say about the RBA readying itself in case a rate cut is in order.

Rudi will be appearing on Sky Business today at noon instead of his usual Thursday appearance.