Stocks advanced after a report that the service sector grew more than expected, and news that new orders and hiring in the sector are on the rise.
The Dow Jones Industrial Average gained more than 150 points, led by DuPont ,  Boeing  , and Caterpillar , and. American Express fell.
The S&P 500 and the Nasdaq also rose. The CBOE Volatility Index, widely considered the best gauge of fear in the market, fell below 23.
All key S&P 500 sectors are higher, led by materials, industrials and financials.
The Institute of Supply Management’s non-manufacturing indexrose to 53.2 in September, up from 51.5 in August. Analysts had expected to the index to be largely unchanged. The report also showed hiring in the sector picked up, as the employment index rose to 50.2, above 48.2 in August, and new orders rose to 54.9 from 52.4.
The market rally comes a day after stocks slippedas Microsoft was downgraded by Goldman Sachs, and traders took profits in materials and tech stocks on a stronger dollar.
On Tuesday, stocks were already higher in part after the dollar weakened. The U.S. currency fell to an 8 1/2-month low against a basket of currencies. Meanwhile, the euro jumped amid speculation the the U.S. will begin quantitative easing.
Two more factors are at play in Tuesday's rally, according to Marc Pado, U.S. market strategist at Cantor Fitzgerald: Federal Reserve Chairman Ben Bernanke's remarks in Rhode Island Monday night, which made "quite clear" the Fed's next move would be to expand quantitative easing; and the move by the Bank of Japan to effectively revert to zero interest ratesto battle a strong yen, Pado said.
"Those two together really reassured the market that we’d see more quantitative easing in the purchasing of bonds," he said.
Also, the fact new orders in the services sector were on the rise as inventories fell, meant companies are operating lean.
"What we are expecting immediate bottom-line profitability: companies are so lean, any new order will have a higher profit margin," Pado said. "These types of numbers are very supportive of an improving fourth quarter."
Financial markets expect the Federal Reserve to embark on another round of asset buying to bolster a sluggish recovery as early as its November meeting. There are also calls within the Bank of England for further easing, although the bank has kept markets guessing on whether it will make that move.
In a speech on Monday evening in Rhode Island, Fed Chairman Ben Bernanke said the Fed's asset purchases had lowered borrowing costs and supported the economy, and more buying could further ease financial conditions.
But investors remained cautious ahead of corporate earnings season and the government's monthly jobs report, due out Friday.
Microsoft is planning to have a tablet computer by Christmas, although it's unclear whether it will be on sale by that time or who will make it. Speaking at the London School of Economics, Microsoft Chief Executive Steve Ballmer said: "You'll see new slates with Windows on them. You'll see them this Christmas," according to Reuters.
Meanwhile, the tech-giant was downgraded by another brokerage on Tuesday. Janney Capital Markets cut Microsoft to "neutral" from "buy," citing the company's unclear strategy for a smart-phone operating system.
Janney also raised Autodesk's fair value estimate to $32 from 30, and Salesforce.com's fair value estimate to $131 from $112.
Home Depot's shares were slightly higher, despite Goldman Sach's decision to cut the shares to "neutral" from "buy."
In financial news, FBR cut American Express' price target to $45 from $48, citing a lawsuit by the Department of Justiceagainst the company, charging Amex with anticompetitive practices. Visa and MasterCard reached a settlement with the government on similar charges.
Several banks were among top-performing stocks after JPMorgan said it expects large-cap bank earnings to beat third-quarter estimates, because of strong mortgage-banking revenues.
The brokerage raised its price target for Citigroup , Fifth Third Bancorp , PNC , SunTrust Banks , US Bancorp , and Wells Fargo .
Walgreen shares rose after posting a stronger-than-expected rise in September same-store sales because of an uptick in pharmacy sales. Same-store sales rose 0.4 percent over the same month a year ago, while analysts had expected a 1.1 percent decline, according to Thomson Reuters.
Talbots shares tumbled after the women's clothing retailer said sales would fall in the current quarter instead of rising, as had been previously forecast.
Meanwhile, Gymboree hired Goldman Sachs to begin a formal auction of the children's clothing retailer, The New York Post reported, citing sources familiar with the situation.Â
Meanwhile, government advisers in Saskatchewan on Monday urged the province not to oppose a takeover, of Potash by BHP Billiton arguing that any possible China-based bid could harm Saskatchewan's economy.
Shares of Chevron rose after the oil company said it would start buying back its own shares in the fourth quarter as part of a buyback program approved earlier by its board to repurchase between $500 million and $1 billion of its shares.
Ahead of this week’s IMF/World Bank meeting, the 16 nations that use the euro are urging China to let the value of its currency rise to help stimulate global economic growth. None of the world's economic powers wants a strong currency right now as a weaker currency provides a competitive advantage.
Jean-Claude Juncker of Luxembourg, the head of the euro group, wants to see a "broad-based appreciation" of the Chinese yuan against the dollar and other major currencies. He said he expressed the view at a meeting Tuesday with Chinese Prime Minister Wen Jiabao.
Also in Europe, Moody's warned on Tuesday that it may cut Ireland's credit rating again, pointing to the huge bill for cleaning up its banks announced last week, a weak economic recovery and rising borrowing costs.
On Tap This Week:
TUESDAY: Intel CEO Otellini speaks; Earnings from Yum Brands
WEDNESDAY: Weekly mortgage applications; Challenger job-cut report; ADP employment report; weekly oil inventories; CTIA Wireless; Earnings from Costco and Monsanto
THURSDAY: Monthly chain store sales; BoE announcement; ECB announcement; Kansas City Fed Pres Hoenig speaks; Consumer credit; Mosaic shareholder meeting; Earnings from PepsiCo and Alcoa
FRIDAY: Monthly non-farm payroll; Wholesale trade; NY Comic Con; IMF, World Bank annual meetings
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