Separate reports on U.S. consumer confidence and European economic sentiment added to the volatility in global markets Tuesday.
In the U.S., consumer confidence fell to its lowest level in 16 months, while the European Union's index of economic sentiment saw a sixth consecutive decline. The pessimism reflects the growing economic uncertainty on both sides of the Atlantic.
U.S. consumer confidence deteriorated sharply in August as Americans grew more pessimistic about jobs and the slow pace of recovery. Despite an uptick in consumer spending, the Commerce Department says U.S. growth has been less robust than expected, expanding at an annual rate of just 1 percent in the second quarter. Economist Gary Burtless at the Brookings Institution says the political debate on deficits and the debt ceiling has made matters worse.
"Nothing that the Congress has done so far this year is going to boost the rate of growth of the economy and, arguably, it's going to - in the short-run - make things a little bit worse over the next 12 months," Burtless said.
While the appetite for spending cuts could increase the risk of another U.S. recession, weak growth prospects in Europe is adding to the pessimism. Germany, considered the powerhouse economy among the 17-nations that use the euro, grew by a mere one tenth of one percent in the second quarter. Analysts say that further complicates the eurozone's ability to underwrite debt-heavy nations such as Greece and Portugal.
The uncertainty could force banks to hike interest rates -- raising the risk of debt defaults among weaker eurozone countries.
Iain Begg at the London School of Economics says the resulting crisis could have a domino effect on banks in the U.S.
"I think we already know the degree of the contagion because we witnessed it in 2008 after the demise of Lehman Brothers, which showed just how heavily interconnected both sides of the Atlantic - indeed the whole world - is when it comes to financial markets. So the risks are considerable," Begg said.
Economist Vincent Reinhart at the American Enterprise Institute in Washington says such a scenario might cause investors to pull their money out of the banking system.
"The extent to which problems in Europe infect financial intermediaries and the extent to which problems in Europe lead investors to withdraw from risk taking generally -- that hits our asset markets," Reinhart said.
Despite the inability of Europe's leaders to find a short-term solution to end the debt crisis, there are a few glimmers of hope in the U.S.
Global markets remain optimistic about the possibility of new action to jolt the U.S. economy when the Federal Reserve's Open Market Committee meets in September.
Investors are also anticipating a big announcement next week by President Barack Obama on a new initiative to encourage U.S. companies to hire more workers.