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Yellen gets a do-over, but will she use it?

Fed Chair Janet Yellen speaks Thursday evening on inflation and policy, a week after the Fed surprised the markets and helped stir up new fears of deflation.

"Her topic is on inflation dynamics and monetary policy. We definitely want to hear what she has to say because the topic is relevant," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. "Does she guide on the near-term outlook for monetary policy? My answer is 'no' because not enough time passed between last week and this week. Nothing changed."

But traders are particularly eyeing her comments on inflation in the 5 p.m. ET speech at the University of Massachusetts, where the audience will not be able to ask questions.

Janet Yellen
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Janet Yellen

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The Fed last Thursday held off on a rate hike, but its real surprise was the more dovish-than-expected message that came with it. It pointed to concerns about international developments—China's slowing growth—and pared back its own economic forecasts, including the one for inflation.

Fed officials last week released a new forecast where PCE inflation is seen rising just 0.4 percent this year, from its earlier projection of 0.7. But it does not now see inflation reaching 2 percent until 2018, pushing it back a year from its June forecast.

Since the Thursday meeting, commodities have tanked, with copper down more than 6 percent and oil down nearly 5 percent. China, meanwhile, has become an even bigger source of concern for markets, now that some worry the Fed might see more dire economic problems that could spread to the U.S. economy.

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Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, said he expects pressure to remain on commodities markets. Copper, viewed as a proxy for global growth, will continue to slide, he said.

"First, global growth has been perhaps weaker than anticipated and the Fed's decision last week, I think, exacerbated those fears that global growth is just not picking up meaningfully. U.S. growth is fine but U.S. growth does not drive commodities demand," he said. "We think that copper has not broken out of a multiyear bear market, and we think prices will head lower and basically see a price of $4,400 a ton or $2 a pound in 2016." Copper futures were at $2.29 Thursday. Blanch said the industry will need to make more capacity cuts.

LaVorgna does not expect a new message on inflation from Yellen. "I think she will be more theoretical and more long-term thinking, in that the Fed is confident that over time it, as a central bank, can generate inflation," LaVorgna said. "For people who are looking for her to give guidance, my guess is they'll be disappointed." He noted the Fed's view is that inflation will ultimately reach 2 percent and that it can raise rates before it does.

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But JP Morgan chief U.S. economist Michael Feroli believes Yellen has a chance to revise the Fed's message. When it held off on the rate hike, the Fed probably intended to practice "prudent risk management," giving itself a little more time to see how financial and international developments play out, he wrote in a note.

"Instead, the message that came across was one of a larger regime change whereby the medium-term inflation outlook had deteriorated and the goalposts for liftoff had shifted," he wrote. "We expect that tomorrow Yellen will attempt to counter this interpretation and instead portray last week's decision as one whereby the Fed just bought a little insurance, and nothing more than that. A message of modest risk management may also help to repair some of the pessimism generated by last week's performance."

The Fed also carries weight when it comes to the economy. He added that "the perception that the Fed has a better read on the economy than the market does can complicate how the Fed sends a dovish message. On this score the chair couldn't find the right balance last week, and we'd expect tomorrow she'll attempt to sound more constructive on the outlook."

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The market is now weighing the odds of an October rate hike, considered less likely than December. The Fed has not raised rates in nine years and has held the Fed funds target rate near zero since 2008.

John Kilduff, energy analyst with Again Capital, said the oil market will take another leg down if Yellen sounds any more dovish Thursday. "Obviously, there's no commodity inflation so it will be interesting to see if she sees emerging disinflation and whether the Fed's going to emphasize that at the expense of a relatively strong employment picture."

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Besides Yellen's talk, there are a few key pieces of data including jobless claims and durable goods at 8:30 a.m. Durable goods are expected to be weaker, declining 2.5 percent. There are also new home sales at 10 a.m.

Accenture and KB Home report earnings ahead of the opening bell, and Nike, Bed Bath and Beyond and Pier 1 Imports report after the close.

Stocks were lower Thursday, with the S&P 500 off 3 at 1,938. The worst sector was materials once more, down 2 percent and reflecting the continued selling in commodities. Energy was second worse, down 1.3 percent. The best sector was utilities, up 0.2 percent.