Wall Street fell more than 1 percent on Monday as fears over the U.S. budget and European debt crises sent a shudder through markets and overshadowed the start of corporate earnings reports.

Renewed concerns that Europe's debt crisis would spread, an increase in Chinese inflation and an impasse in budget talks in Washington converged to jolt investors after Friday's shockingly weak jobs report. The S&P lost its gains for the month, though the Dow and Nasdaq remained modestly in the plus column.

Dashing hopes for a grand bargain to tame U.S. debt, a highly anticipated Sunday meeting broke little new ground as President Barack Obama and congressional Republicans continued to spar over taxes.

While investors still consider it unlikely there will be no deal on the debt, the lack of resolution at a time of growing international concerns weighed on sentiment. The CBOE volatility index <.VIX> spiked 16 percent.

Most investors are giving a low probability to no deal happening, but as we move through the next few weeks and nothing gets done, that probability will go up, said Walter Todd, who helps manage $950 million at Greenwood Capital in Greenwood, South Carolina. He added that if there was no deal, it would be a disaster, a hit to markets around the world.

After two hours of trading, the Dow Jones industrial average <.DJI> fell 146.41 points, or 1.16 percent, to 12,510.79. The Standard & Poor's 500 Index <.SPX> was down 21.21 points, or 1.58 percent, at 1,322.59. The Nasdaq Composite Index <.IXIC> lost 49.61 points, or 1.73 percent, at 2,810.20.

Banks and other economically sensitive stocks fell. Bank of America Corp lost 3 percent to $10.38 while Freeport McMoRan Copper & Gold Inc slumped 3.4 percent to $53.28.

Global equity markets fell and the cost of insuring Italian debt jumped to a record amid fears of contagion in Europe's debt markets and reports some European Union leaders were considering allowing a selective default by Greece.

U.S. exchange-traded funds tracking European equity markets came under heavy selling pressure. The IShares MSCI Italy Index Fund , a fund that tracks Italian stocks, fell 4.9 percent to $15.63. The MSCI Europe Financials Sector Index Fund lost 4.8 percent.

Alcoa Inc fell 4.2 percent to $15.70 ahead of the company's quarterly results after the market closes. The report marks the unofficial start to earnings season and many investors have bet strong results will offset macro-economic pressures.

For a video on the upcoming season, see: http://link.reuters.com/caw52s

Earnings take on increased significance with all these macro issues going on, and it could potentially be a positive for investors to get behind if Alcoa gives a good number, Todd said, adding that recent equity gains heighten the pressure for earnings to be good.

News Corp shares dropped 5.6 percent to $15.81 on heavy volume as Britain looked for a way out of approving the company's multi-billion dollar deal to buy broadcaster BSkyB amid a phone-hacking scandal.

On the upside, Arch Chemicals gained 11 percent to $46.88 after Lonza agreed to buy the company for $1.2 billion.

(Editing by Dan Grebler)

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