Banking reform will likely overshadow the Fed in the coming week, as Congress edges closer to a new financial regulatory reform bill whose effect on the financial sector is still murky.

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Investors will also trawl through housing and other data for signs the economic recovery is on course, after a recent batch of disappointing indicators rekindled fears of a double dip recession.

The Fed's two-day rate meeting should end Wednesday with no policy changes, but the Fed may give a nod to the risks the ripples from the European debt crisis pose for the economy. U.S. economic data, particularly Thursday's weekly jobless claims, could be a problem for markets if it continues to show up weaker than expected.

"The most important things, broadly speaking, that are going to drive the markets over the next couple of months are going to be [financial regulation] and the employment picture," said Jason Trennert, chief investment strategist with Strategas Research.

Concerns about Europe's sovereign debt mess were temporarily pushed aside, and the euro turned in a 2.3 percent weekly gain against the dollar, to $1.2374. The currency got a boost as European leaders agreed to release results of stress tests of major banks. A successful Spanish bond auction also helped the euro and calmed fears that that country would soon seek a bailout of its own.

The Dow rose 238 points or 2.4 percent in the past week, and the S&P 500 also rose 2.4 percent to 1117. The S&P had its best two week performance since November, 2009 and its highest close since May 18. Gold settled at a new high Friday of $1,258.30.

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Investors will also continue to watch BP's mile-deep oil gusher in the Gulf of Mexico, as it increasingly becomes an economic concern and a negative for markets. The energy sector did recover 2.7 percent in the past week.

"It's hard to watch the circus that was before Congress yesterday (Thursday) and feel bullish about buying stocks regardless of your feelings about BP's culpability...So much of this comes down to policy, and there's a relatively small amount of officials and policy makers in Washington, Brussels and Beijing that are casting a very wide shadow over the financial markets," said Trennert.

Citigroup chief U.S. equities strategist Tobias Levkovich said the crisis in the Gulf is negatively impacting companies and stocks, and creating long-term uncertainty about the future shape of the oil industry, and its regulation. But he said the decline in energy stocks has also created a buying opportunity in the sector, which has also been hurt by a stronger dollar.

Financial Reform

The shape of financial regulatory reform is still unclear, as conferees meet on major aspects of the legislation next week. The committee is aiming to reach a compromise that would combine the House and Senate legislation by Thursday, with floor votes the following week.

"Obviously, the desire is to get it done before July Fourth because they all go on vacation. I don't know if you hear a lot more than you've heard this week but you'll probably get a sense of what the bill will look like," Trennert said. The most important issue to resolve is what happens to the swaps businesses of banks, which the Senate bill required be separated from the rest of the business. Under a compromise version, those assets could be retained by parent companies but isolated.

"That's the most important part of it in terms of its immediate potential impact on the financial markets. They're going to obviously be forced to have enough capital so they're going to have to recapitalize that part of the bank. It is also going to be a fairly meaningful earnings hit. It's the devil in the details," he said. "If it's going to raise capital requirements for financial institutions that are already worried about having adequate reserves, it may eventually be good policy, but I'm not sure it's the best policy right now."

On Tuesday, the conferees will take on consumer financial protection and whether to limit fees on debit card transactions.

"If you look at the stocks that haven't made it back above the 200-day moving average, financials are one of them and that's due to [financial regulation]," said Art Hogan, managing director at Jefferies. The S&P financial sector was up 2.3 percent in the past week, but it's down more than 8 percent in the past two months and has been one of the worst performers since April.

Levkovich said he likes regional banks but is staying away from the diversified financials that would be impacted by the bill. "Regional banks...don't have to worry about derivatives, swaps, too big to fail or prop trading for the most part," he said.

Progress on financial reform legislation would also give President Obama a blueprint to share with other world leaders when he reaches the G-20 meeting in Canada next weekend. Obama meet with G-8 leaders in Huntsville, Ontario at the end of the week, ahead of the G-20 meeting in Toronto. G-20 finance ministers have been working toward a more unified approach to regulating the global banking system though an agreement is not expected until the end of the year.

"I'm not sure he'll have anything definitive although I think he can credibly go to G-20 and indicate the U.S. is well on its way to establishing a 21st century regulatory process and I think Europeans will come and say we're addressing our fiscal issues and we have provided reassurance to the markets about the status of the banking sector. I think everybody is addressing the issues that come up in their part of the world," said Robert Sinche, chief strategist at Lily Pond Capital.

"China has clearly focused on its issue and said leave us alone on the currency," he said. The U.S. had been pushing China to let its currency appreciate against the dollar.