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Market Insider: Wednesday Look Ahead

The most sweeping overhaul of financial markets regulation since the Great Depression is unlikely to cause much of a ripple in an already edgy stock market, traders say.

President Obama Wednesday will announce his regulatory reform plan, which is expected to give the Fed new powers over systemically important institutions; create a new consumer financial protection agency and require tougher checks and balances for banks.

Stocks Tuesday followed Monday's down hill pattern, taking the Dow to a 3.5 percent loss in two days. The S&P 500 fell 11 points Tuesday, giving it a total 3.6 percent decline in two days to 911.75, right around its 200-day moving average.

"I think we're going to be in a correction mode now," said Cowen's head trader John O'Donoghue.

"It's going lower," said O'Donoghue. "I'm not looking for a big down. I know a lot of people are looking for a big down. I'm looking for at least 10 percent off the top."

From Fast Money

He said he does not expect Wednesday's economic news to have much impact, nor should the prospect of new regulatory reforms, which must first pass Congress before becoming law.

"I think the market needs to trade more on fundamentals a bit here, than it does on hope," he said. O'Donoghue said the S&P could trade down to the mid to low 800s.

The stock market has been in rally mode since March 9, in large part because better-than-expected economic data provided so-called "green shoots" for market bulls to feed on. But traders are becoming increasingly nervous that those "green shoots" have not yet given way to real signs of recovery and that the economy could in fact take a double dip.

Morgan Stanley analysts Jason Todd and Gerard Minack, in fact, said they believe the economy's performance does not support the market's rally. In a note Tuesday, they said the rally may be over now that the S&P breached 950. They conceded their earlier call to take profits at 850 was too conservative, but they've now set their year end target at 900.

"Equity markets now implicitly need a V-shaped recovery to sustain further gains. We do not expect such a recovery and therefore believe the next move is more likely to be down than up," they wrote. Morgan analysts raised 2009 and 2010 earnings estimates for the S&P to $51 and $62, and brought forward their expectations for the trough in the earnings (ex financials) to third quarter.

"Strategically, we remain cautious on the market and do not believe the current rally represent the beginning of a new bull market," they wrote.

Investors stayed close to the defensive sectors Tuesday, with health care and utilities the best performers among S&P sectors. The health care stocks were fractionally higher, and utilities fractionally lower. Stocks had their biggest two-day drop since late March.

Dollar Dilemma

The dollar meanwhile, reversed course Tuesday, after Russian President Dmitry Medvedev said existing reserve currencies are not working and that a new supranational currency is in the making. The day earlier, the dollar rose after the Russian finance minister said the dollar's reserve status was safe for now. Members of the the BRICs - Brazil, Russia, India and China - gathered in Russia Tuesday in their first summit.

The four countries issued a communiqué, but in their statement they held back from challenging the dollar. They did call for a more "stable, predictable and more diversified international monetary system."

"When you're sitting on about a trillion dollars (of assets), you don't talk the dollar down," said Win Thin, foreign exchange strategist at Brown Brothers Harriman.

The dollar fell 0.32 percent against the euro, to a level of $1.3839. It was off 1.4 percent against the yen , to a level of 96.4413.

"Every time we think the dollar is going to break out, it just stalls at about $1.40 (per euro)," said Thin. "I think the euro is having serious problems. We're kind of at a stale mate here." He said the dollar is stuck in a range of $1.35 to $1.40 per euro.

Wednesday's data includes the the consumer price index, expected to rise by 0.3 percent, or 0.1 percent, minus food and energy. The CPI is reported at 8:30 a.m., the same time as the current account balance for Q1.

Producer prices fell 0.2 percent Tuesday, well below the anticipated 0.6 percent. "Anyone who was complaining about inflation.-- I don't see it. Our factories are below 70 percent capacity.. it's at a record low since the data started in 1967," he said. Capacity utilization, a measure of slack in the economy, was also reported Tuesday to be 68.3 percent, its lowest level ever.

Treasurys moved higher as stocks moved lower. Fed purchases of $6.5 billion in Treasurys were also supportive of bonds. The yield on the 10-year fell to 3.678 percent, its lowest level since June 3, and the two-year was yielding 1.199 percent.

What Else to Watch

Traders will also be keeping an eye on Fed Chairman Ben Bernanke's comments at 9 a.m. on community development financial institutions at the Operation Hope Global Financial Literacy Summit.

President Obama's speech on regulatory reform is at 12:50 p.m.

Economic bellwether FedEx reports earnings before the bell.

California's Dreaming

In other areas of the credit markets, spreads widened on California bonds Tuesday after Standard & Poor's put the state on credit watch, with negative implications. California is struggling with an unresolved budget crisis and is already rated the lowest among states. A spokesman for California Gov. Arnold Schwarzenegger denied news reports Tuesday that the state was seeking a bailout from the federal government.

But Daniel Solender, partner and director of municipal bond management at Lord Abbett, says if not a bailout a lending hand from the federal government would go a long way to calm the market. California has $59 billion in general obligation bonds and another $8 billion in appropriations bonds.

"Within the municipal bond market, they are the largest issuer so anything that happens in California is significant to the market. The news about the negative credit watch was not really a surprise," said Solender.

Solender said he is invested in California bonds. With about a 6 percent yield on the 30-year, they provide better income than other states which yield about a point or more lower. But he also notes the bonds are currently volatile. "It's not like we have default risk here. The issue is more like, if they get downgraded, what kind of downgrade would they have and what does it mean to the market value," he said.

S & P said it believes the state will continue to be able to meet its debt service, but if it fails to adopt sufficient budget reforms that may lead to an increased risk of missed payments. In its statement, Schwarzeneggger's office said the governor has not asked for federal assistance. "Rather, the Governor has spent the last month working with the legislature to find a solution to the state's $24.3 billion deficit. His proposal includes an appropriate level of cuts that will help government live within its means and be fiscally disciplined."

    • White House to California: You're On Your Own

Solender said one outcome for California could be that the U.S. steps in with a plan to make it easier for California to borrow. California cannot afford to be cut off from credit so it will not default if the U.S. won't help, but its government would have to dramatically cut programs, he said. Solender said many in the market had believed the federal government would have helped California by now.

'But there would be a downside to U.S. intervention. "Part of the the issue with government not getting involved with California, is then who is next?" said Solender. He and others have said it could set a precedent where the federal government would begin bailing out states, which are also suffering. For instance, Michigan and Ohio are losing revenues because of the decline of the auto industry.

California though is unique. "The state just has a lot of structural issues. Voters can't approve tax increases," he said but they can push new projects that need funding.

California's major cities are better rated than the state, but its budgetary problems put municipalities and school districts at risk of credit downgrades, Solender said.
In one way, California's high tax rate has been a blessing in disguise for the state. It has helped its sale of bonds as California residents who have stepped up to benefit from their tax free status.

Oil Drill

Oil settled slightly lower at $70.47 per barrel Tuesday, and it weakened further in after hours trading on API inventory data. EIA data is reported at 10:30 a.m. Wednesday.

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Oil traders continue to watch the situation in Iran where thousands demonstrated Tuesday about the outcome of the presidential election. Supporters of President Mahmoud Ahmadinejad and his rival held competing rallies. President Obama said he was concerned about the legitimacy of the election results

The American Petroleum Institute report Tuesday afternoon showed that oil stocks fell by 1.3 illion barrels, less than expected. Gasoline supplies rose sharply, up 2.1 million barrels, compared to expectations they would be down 100,000 barrels.

CORRECTION/Update: In an earlier posting we incorrectly reported that Chicago Fed President Charles Evans was scheduled to speak today. He is not.

Questions? Comments? marketinsider@cnbc.com

  • 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 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.