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Traders Expect Europe to Grab the Wheel Again

Europe will likely hijack control of global markets again Thursday.

European Central Bank
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European Central Bank

“The Street would love to trade on the relative strength of our current economic landscape. It’s significantly more encouraging than looking overseas to Europe. Europe has a way of taking the headlines and really driving the conversation. It doesn’t help that our data isn’t really strong enough to take over the headlines,” said Peter Kenny of Knight Trading.

Weekly jobless claims and durable goods, at 8:30 a.m. ET are the key U.S. economic reports. Claims are expected to be 370,000, even with last week’s level. But traders will also be watching around the world as flash PMI manufacturing data is released for Germany, France and the euro zone.

“I think those trading the euro are a little concerned about this data. The German PMI was a pretty big stunner last month at 46.2,” said Robert Sinche, global head of foreign exchange strategy at RBS. Like the U.S. ISMs, a reading under 50 indicates contraction.

Sinhe said China's HSBC Flash PMI, the earliest indicator of China's industrial activity, which retreated to 48.7 in May from a final reading of 49.3 in April, will potentially move markets.

“Clearly, with the talk of some major stimulus coming out of China, when you hear that talk you can read it one of two ways — either it’s constructive….or you say it’s negative because things are so slow they actually need stimulus,” he said.

For the first time, Markit, which releases international PMI data, will also issue flash PMI manufacturing data for the U.S., which will be a sort of preview for the Institute of Supply Management’s manufacturing survey, reported June 1. The Markit “flash” report will be released at 8:58 a.m. ET, and Markit says it is intended to be the earliest available look each month at business conditions across the U.S. manufacturing sector.

Besides the economic readings, traders will be watching comments from New York Fed President William Dudley, who speaks at the Council on Foreign Relations at 12:30 p.m. But first, he speaks to CNBC’s Steve Liesman, and the interview will first air at 8 a.m. ET.

There are also a few earnings including Costco , Heinz , Royal Bank of Canada , Tiffany , and Toronto Dominion . Verifone reports after the closing bell.

The Treasury auctions $29 billion in 7-year notes at 1 p.m.

Stocks traded sharply lower for much of Wednesday, as worries mounted about Greece, and rumors swirled against the backdrop of an informal European leaders’ summit. The idea that Greece would exit the euro, creating a domino effect that could spur a run on banks in the weaker sovereigns sent buyers into the safety of U.S. Treasurys, the dollar, and German bunds.

The flight to safety provided the U.S. Treasury a receptive market for its 5-year note auction, and the $35 billion auction saw a record low yield of 0.748 percent. Earlier in the day, the German government issued 2-year notes yielding zero. The German 30-year bund traded below 2 percent for the first time ever.

The Dow was down as much as 191 points as fear gripped the markets, but it retraced its losses to finish just 6 points lower at 12,496, and the S&P was positive, up 2 points at 1318. The Nasdaq was up 11 points at 2850. The euro lost 0.8 percent against the dollar, breaking 1.26 and ending the day at 1.258, the lowest level since July, 2010.

Kenny said the fact that the S&P 500 for a second time since Friday hit 1290 and reversed makes it likely that level will be a floor for now. “The trend is still lower,” he said.

“When we were down close to 200 points, it definitely felt like an exhaustion push,” Kenny said.

Stocks recovered after the leaders of France and Italy met and discussed the idea of a euro bond, which has been opposed by Germany. They said they would pursue the idea and it would be discussed at the EU leaders’ June summit, giving traders hope that Germany might ultimately change its view.

While seen as highly unlikely, a rumor that Germany would support a euro zone deposit guarantee program also circulated late in the day, as stocks recovered.

“There was some talk that maybe (German Chancellor Angela) Merkel was agreeing to deposit insurance, which we think was not a high probability event. The thing that was most relevant was the S&P ended up a bit and the Nasdaq closed up, and the euro still has a 25 handle,” said Sinche, noting if there was something to be optimistic about the euro would have rallied.

The euro , in fact, continued to decline late Wednesday, as new headlines from European leaders appeared. French President Francois Hollande said a new government in Greece would be asked to keep its fiscal targets. Whereas, there had been some speculation the EU would work with Greece to adjust its budgetary programs. Without that, there is concern Greeks in their June 17 election would favor parties that oppose austerity measures and force an exit from the euro.

Hollande also said a text from the euro zone leaders’ summit made it clear Greece should stay in the euro zone, as long as it respects its commitments. He also said not all countries share his growth ideas.

Hollande also said he is not aware of any contingency plans should Greece leave the euro. The market has speculated there are such plans because it is feared a disorderly exit by Greece would further undermine confidence in the European banking system and create contagion.

Sinche said the market is watching the German data for signs of weakness. A lack of inflation and a real slowdown in the core could prompt the European Central Bank to consider lowering interest rates. A potential rate cut and the ECB’s LTRO liquidity program “in global standards, that might not be that aggressive but for them that’s a pretty big step,” said Sinche.

Barclays economists note the German IFO index is also released Thursday, and they are watching for parallels between that and the flash PMI.

“The German IFO and PMIs have given differing signals on the momentum of the German economy. While the PMIs have weakened since peaking in January, the IFO business climate has consistently improved,” they noted in a report. “We find the PMI composite index tends to track current output and production while the IFO captures the state of the economy more broadly. If PMI weakness persists, we could see a relatively sharp slowdown of German GDP growth in Q2 2012.”

Follow Patti Domm on Twitter: @pattidomm

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  • 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 Senior Commodities Correspondent and 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.