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Treasury yields were lower Thursday and on Wednesday were lower at the long end of the curve, while yields on some shorter-term duration notes were higher. Those are the ones most affected by Fed rate hikes.
Markets have been bracing for a potential tightening signal from the central bank when it meets next week. The move toward a rate hike comes just as the European Central Bank embarked on an opposite policy path this week, when it launched a bond-buying program.
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The Fed meets Tuesday and Wednesday and is widely expected to remove the word "patience" from its statement. That would signal the markets that rate hikes are on the way, possibly as early as June, but many economists still expect the first hike in September.
"The dollar, to me, looks parabolic," said John Canally, market strategist and economist at LPL Financial. "Did anything change in the last week to drive it like this? Everyone has known the ECB was going to do quantitative easing. The stronger dollar makes it less likely the Fed is going to raise rates because it pushes down on commodity prices. It's a strange mix we're getting this week. It's odd but we're not in earning season so the market is looking around at other things."
Richard Bernstein, CEO of Richard Bernstein Capital Management, said it's likely the Fed will not act to hike yet, even if it takes the word "patience" out of its statement because of a lack of inflationary pressures.
"When was the last time the Federal Reserve openly debated tightening monetary policy when the headline CPI was minus 0.1. Never," he said. "The dollar is telling you there are deflationary pressures around the world."
Bernstein said he is still bullish on stocks and believes "saner and cooler heads will prevail" at the Fed.
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Retail sales and jobless claims are both reported at 8:30 EDT Thursday. Economists project a 0.2 percent increase in retail sales. They also expect to see 305,000 new claims, down from 320,000 last week. There are also import prices at 8:30 a.m. and business inventories at 10 a.m.
A few earnings reports are expected, from Dollar General, Hovnanian, JA Solar, and Vail Resorts before the bell. Aeropostale, Ulta Salon, El Pollo Loco and Zumiez report after the close.
"I think we're at the whim of all the macro things that you get when you're between earnings seasons, and this week it's the dollar. Obviously, it's going to be the Fed early next week," Canally said. He said he'll be watching the claims data for signs of energy industry layoffs after the drop in oil prices.
As for the stock market, the dollar sparked fears that earnings expectations will continue to come down as the currency bites into overseas sales. Sam Stovall, chief equity strategist of S&P Capital IQ, said 2015 operating earnings for the S&P 500 are now expected to be up just 1.1 percent, down from the 9 percent expected in early January.
"While the value of the dollar has been strengthening for a while, I don't think people expected it to get this high," he said. Stovall said he anticipates a choppy market, given it hasn't had a 10 percent correction in 41 months.
"My feeling is that maybe we get what's called a countertrend rally, now that we've gone down a bit, but I still think we have to have a shakeout," said Stovall. "That would make me feel better that we've reset the dials in terms of investor optimism ... we're overdue for one."
Stovall said historically, the stock market has declined about 5 percent or more 3 out of 4 times ahead of the Fed's first rate hike.
"I still think that it's a very good likelihood that we at least eclipse that 5 percent decline threshold," he said, adding it would be a signal to buy. Stovall also notes that technical research shows a break in the S&P below 2,034, along with a VIX move above 20, would be bearish. The S&P is just several points from that level but the VIX was at 16.87 late Wednesday.
Bank stocks will also be a highlight after the Fed waved on capital plans by 29 institutions. The central bank required Bank of America to submit a revised capital strategy by the end of September, and it objected to plans by the U.S. units of Deutsche Bank and Santander.