All eyes on Yellen as Fed watchers await testimony on Hill

Fed Chair Janet Yellen could keep the rally rolling Tuesday, but if there are any surprises, traders expect a violent reaction.

Fed watchers don't expect anything new from Yellen when she appears before the Senate Banking Committee at 10 a.m. ET in her first day of two days of economic testimony on Capitol Hill.

"It seems like the markets love her. Every time she talks, they go up. It almost makes me feel today's rise was a preemptive Yellen party," said Randy Frederick, managing director, trading and derivatives at Charles Schwab. "If she shows just a miniscule of hawkishness, the market will react negatively."

Traders work on the floor of the New York Stock Exchange.
Stan Honda | AFP | Getty Images
Traders work on the floor of the New York Stock Exchange.

Stocks rallied Monday, after Citigroup's better-than-expected earnings and a wave of merger announcements. The Dow was up 111 points at 17,055; the S&P up nine points at 1,977; and the Nasdaq up 24 at 4,440. The Russell 2000 was also up five points at 1,165, a gain of a half percent. Treasury prices were lower, with the 10-year yield at 2.54 percent.

Oil prices were slightly higher with Brent crude up 18 cents, at $106.84, in afternoon trading on concerns that fighting in Libya will interrupt recent advances in production. WTI rose slightly to $100.91 per barrel.

Edward Marrinan, credit strategist at RBS, said Yellen is likely to discuss slack in the labor market.

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"I think she's going to reinforce her message that the economy needs support at this juncture, despite signs of progress," he said. He expects Yellen to veer away from the type of information the market wants to hear—like when will the Fed move to raise rates or how it will start to shrink its balance sheet.

"She's not going to say very much about the exit strategy. I think she's going to use the Jackson Hole symposium to start setting the stage for that," he said. The Fed's Jackson Hole meeting at the end of August has been used by Fed chairs in the past to send important messages on policy.

"Her experience from the one meeting with that six-month gaffe, we're still seeing resonance from that," said Tom Simons, money market economist at Jefferies. He was referring to a comment Yellen made not long after she took on the chairmanship that the Fed could start raising rates six months after the tapering of bond buying ends.

Fed officials have said there is no timeline, and its actions will depend on economic data.

"She tends to be very light on specifics, giving party line answer to questions," Simons said.

The Fed did reveal in the minutes of its last meeting that it expects to end its quantitative easing bond-buying program in October. "I don't think she'll stray from the script," Marrinan said, adding she will choose her words carefully and avoid any time frames on policy that are not public. Marrinan said he expects to see the first rate hike between June and September.

But since the June jobs report was released, the varied views on Wall street about when the Fed will start to raise rates have changed, with some bringing expectations forward.

"I'm steeling myself for disappointment. Everything points to the Fed starting to exit their extraordinary policy a little earlier, but we might get some push back from the chair. I'm just afraid she's going to delay, delay, delay," said Chris Rupkey, chief financial economist at Bank of Tokyo – Mitsubishi. "The hallmark of the Bernanke/Yellen Fed is to delay the exit."

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Besides Yellen, markets will be watching key data and earnings news. Retail sales is released at 8:30 a.m. and is expected to show a gain of 0.6 percent. Import prices and the Empire State survey, are both reporting at 8:30 a.m. Business inventories are released at 10 a.m.

Earnings are due from Goldman Sachs and JP Morgan, ahead of the bell.

"Tomorrow's a big day for the financial story with JP Morgan and Goldman. My suspicion is we'll see a continuation of 'things aren't as bad as we were led to believe'" Marrinan said.

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Goldman profits and revenue are forecast to have declined from last year. It is expected to earn $3.05 per share for the quarter, on revenue of $7.97 billion, off 7 percent from last year.

JP Morgan is expected to earn $1.29 per share, off 19 percent from last year, and the revenue are expected to be down 8 percent, from $23.76 per share.

Other financials reporting include Commerce Bancshares, Pinnacle Financial, Comerica and Interactive Brokers. Besides financials, earnings are expected from Intel, Johnson and Johnson, Yahoo and CSX.

—By CNBC's Patti Domm