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Fed Will Drive the Herd in Week Ahead as Bulls Run Toward Record

Peter Zelei | Vetta | Getty Images

The Federal Reserve could add fuel to the market rally in the week ahead, keeping the Dow on track for its best first quarter since 1998.

There are four housing reports in the coming week but the Fed is the main event. It holds a two-day meeting, which ends with the release of its policy statement, economic forecasts and a press briefing by Fed Chairman Ben Bernanke Wednesday afternoon.

Stocks closed out the past week with a gain, but the S&P 500 fell short of recovering its 2007 closing high. The S&P closed up 0.6 percent at 1560, short of the 1565 record closing level of October 2007. But analysts expect the S&P to cross that threshold soon and take aim at the all-time intraday high of 1576.

"It's entirely possible," said Barry Knapp , head of equity portfolio strategy at Barclays. "If the Fed comes and goes, and people like what the chairman says at the press conference, it certainly is possible to breakthrough to a new high. That makes some intuitive sense."

(Read More: Fed Sent Record $88.4 Billion to US Treasury Last Year)

Analysts, however, are expecting a pullback soon after, and have been looking for one for weeks. But the Dow has kept moving higher, blasting through its all-time high on March 5, and is still gaining. The Dow was up 0.8 percent for the week, finishing at 14,514, despite a slight loss of 25 points Friday. But Knapp thinks the market will find enough reasons to rise — at least until the middle of April.

(Read More: How to Play the Market Pullback That's Coming: Analyst)

"From a timing perspective, in terms of when we're likely to start to see disappointing data, and we get closer to earnings, it's when you get into mid-April. I would be surprised if we get much of a correction before that," Knapp said.

The Dow is up 10.8 percent so far this quarter, and historically when the first quarter is sharply higher, the market ends the year with a gain. In the 12 times the Dow was up more than eight percent in the first quarter since 1950, the Dow finished positively every time and finished with double-digit gains ten times. The Nasdaq is up 7.6 percent for the year to date, and the S&P is up 9.4 percent.

Fed Ahead

A series of stronger-than-expected data, including February's 236,000 non-farm payrolls and the surprise 1.1 percent jump in retail sales, has sent Treasury yields rising and has stirred speculation about the Fed's plans for easing. But Fed watchers do not believe the data has been strong enough to turn the Fed from the path of quantitative easing or its ultra-low rates policy.

Still, traders are watching for any sign that the Fed is even discussing ending its easy ways. The minutes of recent meetings have revealed that some Fed members would like to end easing sooner rather than later and are concerned that it may no longer be effective. Those comments in the December and January minutes have had an effect on the bond market.

But on Friday, traders bought Treasurys into the close, driving the 10-year yield to 1.99 percent, a sign to some that the market is anticipating a dovish Fed on Wednesday.

"I think that Ben Bernanke's objective will be to convey the idea that the Fed is not about to take the punch bowl away because the party hasn't even started yet in terms of economic growth, and given the high level of unemployment," said Tony Crescenzi, strategist and portfolio manager at Pimco. "Yes, markets are feeling better, employment statistics are looking better, but the rocket's not taking off yet."

Crescenzi said one thing the Fed may do is adjust its forecast. For instance, in December it expected to see 2.3 to 3 percent GDP growth this year, but it could tweak that to include a hit from the sequester. The sequester is the automatic spending cuts that were put into effect when Congress failed to act on a spending plan. In the coming week, Congress is expected to work toward adopting a continuing resolution to keep the government running through May, from the current March 27 deadline.

Crescenzi said the Fed will probably maintain next year's forecast of 3 to 3.5 percent GDP growth.

"Markets have come to the belief that the economy is improving. If the Fed rubber stamps that view and then Bernanke seems to be in his press conference leaning toward the optimistic camp, that would be a surprise. But it's not expected," said Crescenzi. "What's expected is there'll be some upgrade in the assessment of growth but this in no way means the Fed is going to take the training wheels off because the economy has not yet reached escape velocity."

Crescenzi said if the employment picture keeps improving and jobs continue to grow at February's pace, or better, for several months, the Fed could start discussing a strategy to exit its easing policy at its June meeting. The Fed is currently buying $85 billion in mortgages and Treasurys each month, in an effort to keep rates down.The Fed's easy policies has also helped the stock market, so Knapp said the market could sell off if the economic data improves so much that it looks like the Fed will reverse course. At the same time, it could sell off if the economic data worsens, he said.

"I think the formal stuff that comes out of this meeting is going to be pretty much status quo," said Nathan Sheets, global head of international economics at Citigroup. "One reason why I think that's the case is that Bernanke and (Fed Vice Chair Janet) Yellen have been doing a lot of talking over the last few weeks, and they've aligned the market's thinking with their thinking."

Sheets said he thinks the statement will be very similar to the January Fed statement. "They need to do a little tinkering in the first paragraph, where they say the economy stalled. Obviously, it's not stalled anymore," he said.

(Read More: El-Erian: Fed Now Facing One of Its Toughest Jobs Ever)

Housing is one bright spot that economists point to as a source of momentum for the broader economy, including in hiring. It is also propping up consumer spending and confidence, despite headwinds from high gasoline and higher taxes. Sheets said if the Fed were to wind down some of its purchases this year, it would probably continue its purchases of mortgages to keep the housing market rebound in tact.

This week's data includes the NAHB home builders survey Monday; housing starts Tuesday and existing home sales Thursday. The FHFA home prices data for January is also released Thursday.

Sheets said he doesn't expect any news from the Fed meeting that would break the 10-year yield out of its range. "My feeling is we range trade between 1.85 and 2.10," said Sheets.

"If we see the economy starting to pick up, my sense is maybe at the July Humphrey Hawkins (Congressional testimony), Bernanke might make some comments about the economy getting better," he said.

What Else to Watch

Sheets said he is also keeping an eye on Europe in the week ahead. "I think the big open issue for Europe is how these Italian elections are resolved…That's what I'll be watching," he said. Italy failed to form a government after close parliamentary elections left no clear victor.

There are just a few earnings, including Nike, FedEx and General Mills.

(Read More: Cramer's Game Plan: Is a Wild Week Coming?)

The stock market is also watching Apple, which gained 2.8 percent in the past week, as investors increasingly believe it may have bottomed. There is also continuing speculation that Apple could announced dividend or stock buyback news, since Monday is the first anniversary of Apple's dividend announcement.

(Read More: Apple Stock Spikes: Chart 'So Bad That It's Good')

Week Ahead Calendar

Monday

10:00 am: NAHB housing index

Tuesday

Fed begins two-day meeting

Earnings: Adobe Systems, Tumi, DSW, FactSet

8:30 am: Housing starts

8:30 am: Building permits

Wednesday

Earnings: FedEx, General Mills, Jabil Circuit, Oracle

7:00 am: Mortgage applications

10:30 am: Oil inventories

2:00 pm: FOMC rate decision

2:15 pm: Fed Chairman Ben Bernanke press briefing

Thursday

Earnings: Nike, Lululemon Athletica, Ross Stores, Worthington Industries, Silver Wheaton

8:30 am: Jobless claims

9:00 am: FHFA home price index

10:00 am: Existing home sales

10:00 am: Philadelphia Fed survey

10:00 am: Leading indicators

10:30 am: Natural gas inventories

Friday

Earnings: Darden Restaurants, Embraer, KB Home, Tiffany

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Senior Commodities Correspondent and Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.