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The big challenge for markets in the week ahead

The quiet trading days of late May could fade fast as markets brace for two major events towering at the end of the week—a rate cut in Europe and the U.S. monthly jobs report.

The European Central Bank European meets Thursday and is widely expected to cut its deposit rate, putting it into negative territory for the first time, and take actions to promote small business lending. The ECB has been signaling that it could take action, including in comments from Mario Draghi, ECB's president, who set the table for a move following the last rate meeting.

There is a heavy calendar of economic reports in the U.S., the most important of which is Friday's May employment report. Economists expect job creation to have slowed from April's 288,000 nonfarm payrolls but still come in above 200,000. While there are few earnings reports, Apple promises to grab headlines when its Worldwide Developers conference starts Monday and when its stock splits 7-for-1 later in the week.

Traders on the floor of the New York Stock Exchange.
Getty Images
Traders on the floor of the New York Stock Exchange.

But the biggest focus for world markets will be the meeting in Europe.

"Perhaps the biggest challenge after many months of just saying stuff, the ECB is finally going to do something," said Marc Chandler, chief foreign exchange strategist at Brown Brothers Harriman. "The euro has fallen 4 cents since early May. This is among the worst-performing months for the euro in a year. I think this is the market preparing for the ECB on June 5." Chandler says the ECB could also cut its lending rate and refi rate.

Bond yields have also moved lower ahead of the move, and the ECB was one of the reasons for a sharp move lower in U.S. yields this past week. By Friday, the 10-year yield had reversed some of that move and was at 2.46 percent.

"I think they've well-choreographed the direction they're going in," said Rick Rieder, co-head of Americas Fixed Income at BlackRock. "I think they cut the deposit rate, and I think they lay out the series of steps or at least the framework for which they do asset purchases."

As for U.S. data, the ISM manufacturing and nonmanufacturing data, released Monday and Wednesday, should be important both for business activity but also for what the reports say about hiring. The market will also be primed for Friday's jobs report by ADP private-sector payrolls on Wednesday.

"We think this will be another good report," said Barclays chief U.S. Economist Dean Maki. "We're at 225,000, a good solid number. We're also looking at unemployment rate to be unchanged at 6.3 percent." Maki said he does see a chance the participation rate rises, but that any rise in participation would be absorbed by job growth so it will not affect the unemployment rate.

Read MoreRosier GDP forecasts ahead after Q1 contraction

"I think the payroll number is going to be pretty significant. If we get an around consensus number, that takes the three-month average to 230,000, and that's a pretty good number relative to where we've been, and that could certainly start the process by which the Fed starts to normalize rates, or starts to think about a program to bring up the funds rates," Rieder said.

Rieder said long-term rates should start to rise from this week's low levels, though it's possible yields could still move lower first. "We think the data should be pretty solid, and from everything we're able to glean from corporate earnings and surveys, the data over the next couple of weeks and next couple of months should be pretty solid and exhibit a bounce back from the weakness of the first quarter," he said. "We think rates are going to drift higher. I think we could be in a range that's lower for a period of time because of the incredible nature of policy in the U.S., the ECB and the Bank of Japan." By year's end, he expects the 10-year yield to be at 3 to 3.25 percent.

Even as the Fed tapers back its bond purchases, its ballooned balance sheet is helping keep downward pressure on interest rates.

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The move lower in rates this month initially spooked stock traders, but stocks moved to record highs in the past week even as bond yields fell. Stocks also finished the month of May higher and were positive for the week.

The Dow gained for the week, ending at a record high of 16,717.17, and the S&P 500 was up 0.2 percent, for a record high of 1,923.57, a gain of 1.21 percent for the week. Nasdaq was down 0.1 percent at 4,242.62, leaving it up 3.1 percent for May.

The central bank activity and an improving economy should provide a positive backdrop for stocks for now, some strategists believe. With the exception of the Russell 2000 this month, stocks have not had a major correction since 2011, and some traders are concerned the current low volatility is a contrarian sign that things could get rocky.

"There are a number of things that show this economy is going to be stronger next year," said Stewart Freeman, chief U.S. equity strategist at Wells Fargo Advisors. "(The stock market) chopped higher. We've been going through this rotation of groups all year long…Sometimes, that's how the market corrects."

Freeman expects to see the S&P 500 between 1975 and 2025 by year's end, but he says volatility could pick up between now and then. "As we go forward, in the next 18 months this market is going to be drive by the companies that benefit from cyclical growth," he said, noting he recommends overweights in industrials and technology.

"We're at the point in the cycle where everybody's trying to figure out what the Fed is going to do next, and when," he said. "We've seen somewhat of a run on Treasurys, on bonds on the long end, and as the economy continues to grow, we'll eventually have more inflation."

But for now the move in bonds is not a concern, and the atmosphere is right for stocks to move higher. "Rates are low, inflation is low. That's generally good for stocks. Plus we're continuing to see good leading indicators for the economy. I think we'll be higher at the end of the year, and we think we're going to hit more new highs on the way there," he said.

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What to Watch

Monday

3:00 a.m.: Chicago Fed President Charles Evans

10:00 a.m.: ISM manufacturing

10:00 a.m.: Construction spending

Tuesday

Vehicle sales

10:00 a.m.: Factory orders

1:50 p.m.: Kansas City Fed President Esther George on monetary policy

Wednesday

8:15 a.m.: ADP employment

8:30 a.m.: International trade

8:30 a.m.: Productivity and costs

10:00 a.m.: ISM nonmanufacturing

2:00 p.m.: Beige book

Thursday

European Central Bank rates meeting

Chain store sales

8:30 a.m.: Weekly jobless claims

Friday

4:50 a.m.: Fed Gov. Jerome Powell on central bank issues

8:30 a.m.: Employment report

3:00 p.m.: Consumer credit

—By CNBC's Patti Domm

  • 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's Senior 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.