Volatile trading in stocks and bonds could continue as investors sort out what's going on with the Fed and whether markets have come to some sort of inflection point.
That makes every bit of economic data even more important, since the Fed has made clear its path will be determined by the progress of the economy, and employment in particular.
(Read More: Pisani: Traders Overreact to Bernanke's Testimony)
Thursday's reports include weekly jobless claims at 8:30 a.m. ET; U.S. manufacturing PMI at 8:58 a.m..; FHFA home prices at 9: a.m. and new home sales at 10 a.m. U.S. markets will also be watching PMI data for China and the euro zone.
Fed Chairman Ben Bernanke's appearance Wednesday before the Joint Economic Committee in Congress brought out little new information, but it sure sounded different to markets that went on a volatile roller-coaster ride during and after his testimony. First stocks and bonds rallied together when his dovish prepared statement appeared to push off the idea that the Fed would start tapering down its $85 billion monthly purchases of mortgages and Treasurys any time soon.
But then selling took hold when Bernanke was questioned about the unwinding of quantitative easing. He said the Fed could start paring back purchases in a couple of months, and even though New York Fed President William Dudley had publicly said the same thing, markets went into a tail spin. That sparked selling across markets, including gold, which reversed its sharp gains. The 10-year Treasury yield closed above 2 percent for the first time since March.
"You've got a conflicted Fed. They've been conflicted for a while. They're worried about the long term, and how do we unwind this, and they're worried about the economy in the short term," said Art Hogan of Lazard Capital Markets. Hogan said that message collided with a thinned out trading crowd ahead of the long Memorial Day weekend.
Traders said the activity underscored the fact that there are very varied views on when the Fed would start to lighten up on its asset buying, a first step in what promises to be a long process of unwind. Some investors had been prepared for the Fed to slow down buying as soon as June, and now anecdotally, they have moved their expectations to anywhere from September to next year.
"This could be an inflection point for the stock market. It's been 180 days without a five percent correction," Hogan said.
Stocks resumed their uptrend during Bernanke's morning testimony but sold off again just ahead of the 2 p.m. release of Fed minutes, which showed a "number" of Fed officials thought tapering in June would be a good idea. The Dow closed down 80 points, or a half percent at 15,307, after trading up more than 150 points early in the day. The S&P fell 13 points, or 0.8 percent to 1655, and the Nasdaq skidded 1.1 percent to 3463.
Even with the drama in stocks, the CBOE VIX, or volatility index, was up just 3.4 percent Wednesday at 13.82, and stock futures were mostly higher Wednesday evening. Dow component Hewlett Packard was up 14 percent after hours on positive earnings news. Treasury yields also continued to rise Wednesday evening, with the 10-year touching 2.06 percent.
"We've been cruising for a while," said David Bianco, chief U.S. equity strategist at Deutsche Bank. "This is just a market that's been up every day for days and days now. I've been of the mindset that this is basically as high as we're going for a while, and we'll see what happens. I'm not surprised to see the pullback. I don't think it has to do with the Fed minutes. They communicated things largely along the lines of what was expected."
(Read More: Rallies End Sometime, but This One May Not End Soon)
Bond Market Jitters
Stocks were also rattled in the afternoon by the bond market selloff. "We finally closed over 2 percent for the first time in a while. We've got this rise in real interest rates," Bianco said. "That's kind of consistent with people feeling better, and stability. There's been some growth, and tapering is coming eventually. We're now nowhere near where rates look like they're going to surge, or go near historical norms."
John Canally, investment strategist and economist at LPL Financial, agreed that the Fed's message Wednesday was not particularly new. "Bernanke's testimony on the margin is more dovish, and it's all data dependent. People were looking for a reason to sell, and this is it," he said.
"We've seen increased volatility, and that hasn't been around all year. This talk of the Fed exiting or tapering that will almost by default introduce any volatility," said Canally. But if the market shifts focus, the volatility could disappear.
(Watch Now: What to Make of Bernanke's Testimony?)
"We shouldn't pay attention to the Fed. We should pay attention to the data. If the data says, it's getting better, they're going to taper or test sooner," he said. Canally said the market will watch the jobs data, and if it gets weaker, the Fed will ease for longer. "Tomorrow's (Thursday) data on claims is important," he said.
The S&P Wednesday morning hit Tuesday's intraday high of 1687 before selling off, giving it an "outside day." "You had a fast, furious move above yesterday's high, so that basically made the shorts capitulate and people chased excitement, and then you fell back below that level," said Scott Redler of T3Live.com. He said an outside day can lead to a short-term directional change.
"I don't' think the highs of the year are in yet, but I think both the bulls and bears would welcome a three-to-five percent correction here. We've been extended for a long period of time. You never know what this kind of day will lead to," he said.
Redler said now it will depend on how the market trades. "If we don't get a potent bounce in the next day or two, we could see it continue," he said.
The Treasury market saw one of its biggest days in terms of volume in years. David Ader of CRT Capital did a quick look back over four years of volume data, and he couldn't find as big a day. He said volume was about 180 percent of the 10-day average.
"Everyone has been long mortgages…now all of a sudden, you throw a wrench in the works where the Fed might, instead of buying all of the mortgages, would be buying say 80 percent. So, you have people spooked," said Ader, chief Treasury strategist at CRT. He said there was panicky selling in that market, which spilled into Treasurys.
"It's a hedge and you have another major fixed-income instrument selling off. We're not going to stand still when something as big as mortgages are selling off. We're going down in sympathy," he said.
He said the uncertainty about the Fed, and the possibility it could ease sooner than expected could keep rates higher for now. "The Fed's going to be tempered here, and we still have ambiguity. For the moment, it's going to lift the (yield) range a little bit," Ader said.
"We are addicted to the Fed, and the withdrawal process is going to be painful, and I think the Fed has an interesting time ahead of it…the move for stocks today was not a happy camper," he said.
Canally said the 2 percent 10-year yield spurred talk that corporations would cut back on debt issuance, which some have been using to buy back stocks. That would be a negative for the market, he said.
(Watch Now: TheMerits of Investing in US Treasuries)
Ader said a 2 percent yield might be enough to draw in Japanese buyers who were waiting for an opportunity to put more money into U.S. government bonds. "We've been speaking about this for a week. The currencies are favorable now too," he said.
What Else to Watch
St. Louis Fed President James Bullard speaks at 6:05 a.m. in London on monetary policy and the economy. Bullard's comments endorsing continued easing earlier this week were market moving.
There are a number of earnings ahead of the opening bell, including Dollar Tree, ING U.S., Toronto Dominion, Sears Holdings, Ralph Lauren, Hormel Foods, The Buckle, Advanced Auto Parts and Patterson Cos. Gap, Salesforce.com, Williams-Sonoma, Zumiez, Pandora and Aeropostale report after the closing bell.