Sovereign debt issues on both sides of the Atlantic could be what drives markets Thursday, as traders also get another dose of testimony from Fed Chairman Ben Bernanke.
Weekly jobless claims, retail sales and J.P. Morgan's earnings are also trio of important market catalysts, expected ahead of the U.S. open.
Moody's late Thursday raised the temperature on the debt ceiling discussions in Washington, saying it was putting the U.S. AAA credit rating on review for possible downgrade because there is a rising possibility the statutory debt limit will not be raised on a timely basis. The dollar and stock futures moved lower on the news.
Traders have been watching deliberations and are becoming more sensitive to comments on the debt ceiling and deficit discussions even though market expectations are that the debt ceiling will be raised by the Aug. 2 deadline, despite squabbling in Congress.
Talks Wednesday were reported to be especially tense and Republicans reported President Obama ended the meeting by walking out. Democrats said he walked out after being interrupted by House Majority leader Eric Cantor.
Fed chairman Ben Bernanke is back on Capitol Hill, this time before the Senate Banking Committee and traders will be listening for any clarity on what would make the Fed move closer to another round of quantitative easing.
Europe is also back in focus as Italy auctions as much as 5 billion euros in debt and its government acts to drive an austerity package through the lower house of parliament by Friday.
"This has been a week of roller coaster twists and turns in the currencies, and I think it's going to continue because tomorrow...we face the Italian auctions, which are going to be critical," said Boris Schlossberg of GFT Forex.
"The Italian Treasury is basically going to put its toe in the water tomorrow for the first since we have had massive moves in the CDS (credit default swaps)," said Schlossberg. "...This was not a pro-euro rally. It's just an anti-dollar sell off. We very easily can flip directions tomorrow if there's any kind of hiccup in Italian conditions or if there's more bad news on the bank stress tests in Europe."
The euro was above 1.42 in early evening trade Wednesday, after dipping below 1.40 Tuesday.
Traders Wednesday were also buzzing about a small German bank, Helaba which pulled out of the stress test to avoid a failure. The results of European stress tests on 90 financial institutions are expected to be released Friday.
A New QE?
Stocks rallied, and the Dow initially saw a triple-digit gain Wednesday morning on comments from Bernanke that seemed to tilt slightly more toward the possibility of another round of quantitative easing, or QE3. Markets giddily latched on to idea of more easing, the last round of which - QE2 - helped drive risk assets , like stocks and commodities higher.
But by the end of the day, stocks gave up much of their gains, and the Dow was up just 44 at 12,491, and the S&P 500 gained 4 to 1317. Comments from Dallas Fed President Richard Fisher dashed some of the expectations for more easing. Fisher said the Fed has pressed the limits of monetary policy and that banks and businesses are already awash in liquidity.
"Stocks started coming back down after Bernanke finished speaking, and then Dallas Fed's Fisher didn't sound too enthusiastic about new extraordinary policies underlying QE and then I think they ran out of momentum," said Art Cashin, director of floor operations at UBS. Cashin said the post-Bernanke analysis was also a factor as traders started to question whether the Fed would undertake a new QE program as there are no signs of deflation. a requirement for further easing.
Under the QE2 program, the Fed purchased $600 billion in Treasury securities.
"I think the bar is very high for QE3, and people should be careful what they wish for," said Peter Boockvar, equity strategist at Miller Tabak. "He's (Bernanke's) not going from one QE to another QE just because we had a bad payrolls number. There has to be something bad in between. He's not going to do QE3 with the S&P at 1300. He's going to do it at 1100."
AAA Going Away?
Traders are also more closely monitoring the ebb and flow of the debt ceiling and deficit reduction discussions, as the deadline draws near.
In its release, Moody's said it considers the probability of a default on interest payments by the U.S. to be low and that the type of default would be short lived, resulting in minimal or no loss to holders of Treasurys. The most likely downgrade would be to a AA rating, it said.
Illustrating the divide between the White House and Republicans, House Speaker John Boehner released a reaction to Moody's warning stating that if the White House does not take action to reign in spending, the markets may do so instead. The Treasury Department also issued a release, commenting that Moody's action was a timely reminder for Congress to move quickly to avoid default.
What Else to Watch
Thursday's data includes retail sales, weekly jobless claims, and PPI, all at 8:30 a.m. Business inventories are at 10 a.m. Treasury auctions reopened 30-year bonds at 1 p.m.
Retail sales and weekly jobless claims are both being watched closely after last Friday's June employment report showed a surprising weakness in net job creation and the question now is just how weak is the economy. Retail sales for June are expected to be down 0.2 percent. Jobless claims are expected to stay elevated, at 420,000, and according to economists, may be reflecting a higher level of layoffs than seen earlier in the year.
"Retail sales is interesting. Whenever retail sales comes out the market responds to it. Last week, we already saw the chain store sales numbers and we saw the vehicle numbers and there is a good chunk of retail sales. Chain stores sales were better than expected, and vehicle sales were weaker than expected," said Boockvar.
Earnings Central
Boockvar said earnings should start to grab more of the market's attention. "I think from here on, for the next three weeks, it's all earnings. If you look at yesterday's action outside of Europe, it was all earnings related. I think the Microchip news was a canary in the coal mine, not because of the technology, but because they have customers throughout industry..I think there is going to be a lot of disappointment. ASML, Novellus (both with disappointing forecasts) are very chip-related. Microchip sees into many industrial areas. To me, that was a lot more telling. I think the Microchip comments about their end customers was very disconcerting," he said.
J.P. Morgan, before the bell, and Google's report, after Thursday's close, are among the first big names to report this earnings season.
"I think there are macro headwinds that are more salient to how the market does in the longer term, but certainly you'll get a short term reaction to J.P. Morgan earnings," said Peter McCorry, a trader with Keefe Bruyette.
J.P. Morgan is expected to earn $1.21 per share on revenues of $25.10 billion. Google is expected to report $7.85 per share on revenues of $6.55 billion for the quarter.
Marriott , which reported after the bell, saw its stock get smacked Wednesday when it released a forecast that was slightly below its prior guidance. Marriott earnings rose 13 percent to $135 million, or $0.37 per share, and were in line with expectations. Yum , which owns Taco Bell and Pizza Hut, reported higher than expected earnings of $286 million, and was helped by strong growth in China. Its stock moved higher after it raised full year guidance.
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