Higher yields sting stocks as jobs take center stage

ADP's private sector payroll data will be key for bonds, stocks and the dollar on Wednesday morning, and it could set the stage for an even bigger move in financial markets when the government jobs report is released Friday.

"What in theory could happen is if that number comes in on the high side, (stocks) could continue trading down based on this whole idea that interest rates need to rise a little bit more," said Julian Emanuel, equity and derivatives strategist at UBS.

Interest rates already have already been rising, and a combination of higher yields and a surprise widening of the U.S. trade deficit was a toxic combination for stocks Tuesday. The Nasdaq, small caps and high fliers felt the brunt of the pain. The Nasdaq fell 1.5 percent to 4,939, compared with the S&P's 1.2 percent fall to 2,089. The Dow, Nasdaq and S&P all closed below their 50-day moving averages.

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"It doesn't feel like it's quite over," said Emanuel. "But if you get better-than-expected (jobs data on Friday) that's the kind of thing that could cause more discomfort in the market and it might create a flush out of sorts, and that sets up the next buying opportunity."

ADP is expected to report at 8:15 a.m. ET that there were 205,000 private sector payrolls added in April, and while it's not necessarily a reflection of what's in the government report Friday, any jobs data is more important this month because of the surprisingly weak 126,000 March nonfarm payrolls.

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"If you have a very strong number, this market (Treasurys) could move to the downside," said Justin Lederer, rates analyst at Cantor Fitzgerald. Yields move opposite to bond prices. Lederer pointed to the drama in Treasurys where the 30-year yield rose above its 200-day moving average Tuesday, to 2.91 percent, and the 10-year traded above and then hovered near its 2.19 percent 200-day moving average.

"A lot of people are already looking toward Friday to see if last month was an outlier," Lederer said. Bond yields have risen faster at the long end, following the German bund which is responding to stronger data in Europe. With the launch of European quantitative easing, U.S. yields had moved lower in lockstep with the bund as the German 10-year got extremely close to zero and was expected to turn negative.

"It seems like whatever other markets are doing, the U.S. Treasury market is following. We're seeing some of the frothiness come out of the bund. To me it makes perfect sense for whatever reason, you could see some of the frothiness come out of U.S. Treasurys," said Jim Caron, global portfolio manager at Morgan Stanley Investment Management. Caron said he expects to see the bund yield continue higher.

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Economists Tuesday slashed their expectations for first-quarter GDP, which was reported last week at 0.2 percent. The consensus forecast for the second reading is now a decline of 0.4 percent, according tothe CNBC/Moody's Analytics Rapid Update. The jobs number will be the most important piece of second-quarter data so far, so it will be weighed carefully for what it may mean to the Fed in its move toward higher rates later this year.

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The timing of the Fed's first rate hike is now expected to be in September at the earliest, but every piece of data has the potential to create an outsize move in markets as traders try to handicap the timing.

The dollar traded lower Tuesday, with the euro falling back to $1.11, and its recent weakness has come in the face of higher yields.

In the stock market,the small cap Russell 2000 declined with the Nasdaq Tuesday, losing 1.4 percent, and the high-flying biotech IBB, iShares Nasdaq Biotechnology ETF lost 2 percent.

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"Small caps were expensive," said Jeff Saut, Raymond James chief investment strategist. "And the crowded trade was everybody piling into the small caps trade because they didn't have forex risk." But the dollar has given back some gains, and the group looks even pricier, he said.

As for biotechs, "if there's something bubblicious it's biotechs. The tell was Friday when (IBB) broke the trend line," Saut said.

Emanuel said it will ultimately be time to buy the dip in stock prices. "We definitely are buyers of the dip, but the difference here is you are in a transition mindset. Peoples' attitude toward interest rates, we believe, needs to change. What they need to do is they need to understand that higher interest rates are all part of the normalizing global rebalancing process. It's trite, but it's true."

"We came into May with two worries: First was earnings, second was the economy.... The problem nobody was expecting, literally nobody, was expecting to be concerned about rising interest rates. It caught us by surprise," Emanuel said, noting earnings have not been as weak as expected.

Besides ADP, there is productivity and costs for the first quarter at 8:30 a.m. ET, and some major Fed speakers. That would include Fed Chair Janet Yellen, who is on a panel in Washington with IMF managing director Christine Lagarde. The topic of the 9:15 a.m. ET panel is finance and society.

Kansas City Fed President Esther George speaks at 1:15 p.m. ET at the IMF in Washington on credit market booms, busts and distortions. Atlanta Fed President Dennis Lockhart speaks at 1:30 p.m. ET in Baton Rouge on the economic outlook.

Earnings are expected from A-B InBev, GlaxoSmithKline, Occidental Petroleum, HollyFrontier, Hain Celestial, Motorola Solutions, Chesapeake Energy, Wendy's, SodaStream and Wellcare Health, before the market open. Tesla Motors, 21st Century Fox, MetLife, Activision Blizzard, Keurig Green Mountain, Whole Foods, Caesars Entertainment and Continental Resources report after the close.