Bernanke Speaks as Italy Becomes New Market Headwind

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Fed Chairman Ben Bernanke is expected to provide soothing words about the Fed's easy money policies Tuesday, but markets may react more to new bearish concerns out of Europe.

Markets were rattled Monday after the Italian election failed to produce a clear winner, and threw into question whether a government can be formed from a cobbled together coalition. The Dow had its worst day since Nov. 7, losing 216 points or 1.6 percent to 13,784. The S&P 500 lost 1.8 percent to 1487, and the Nasdaq lost 1.4 percent to 3116.

Bernanke appears before the Senate Banking Committee at 10 a.m. ET, in his first of two days of Congressional testimony on the economy. Traders had expected Bernanke to counter market concerns that some Fed members would like to end quantitative easing early. In the minutes of the last two Fed meetings, there was clear discussion about the end of easing, and it was noted that some Fed members wanted an earlier end to quantitative easing.

"I think that Bernanke's got a much trickier speech now tomorrow. Had the Italian elections gone as expected, he would reassure the market they weren't going to take away the punch bowl and you would have had a Bernanke bounce," said Barry Knapp, head of equities portfolio strategy at Barclays. "Now they've had the weak (PMI) number from China, and if he says too much about global growth being weak…it's not clear the markets will react too favorably towards that."

The Fed chairman is expected to defend the Fed's quantitative easing (QE) program, under which it purchases $85 billion in Treasurys and mortgage securities each month. He is expected to make it clear the Fed's easy money policies would stay in place as long as needed, but he is also likely to field questions about how the Fed intends to unwind its extraordinary easing programs which have added trillions to its balance sheet.

Bernanke is also expected to be asked about "sequestration," the $85 billion in automatic spending cuts for this year, expected to start March 1 if Congress doesn't act.

(Read More: Bernanke May Limit Oil's Decline With QE 'Defense')

"The QE effect will be with us for a while. I think he's going to reinforce that," said Jens Nordvig, head of G-10 currency strategy at Nomura. "The core of the FOMC still believes aggressive stimulus is still needed, and they're not going to remove it."

Knapp said the stock market is due for a pullback, and it may continue to be choppy. Without the Italian election, "I thought Bernanke might push us back to highs," Knapp said.

Oppenheimer Asset Management chief market technician Carter Worth also believes the market is set for a pullback, and he's been recommending selling stocks.

"Three days won't solve it. It should be weeks of selling," he said, adding a 2 percent decline is not a sell off but just a dip. "It's a garden variety sell off, something in the order of five to six percent, or five to seven, or five to eight percent. That's a garden variety."

"This is not just stocks. Gold is not acting well, copper isn't acting well and bonds, with the exception of today, have not been acting well...something doesn't dovetail out there. Something seems not right," he said.

(Read More: Gold Loses Friends as Funds Sell, Investors Flock to Risk)

Volatility also shot up Monday, with the VIX jumping 35 percent to 19.28. The Chicago Board of Options Exchange's Volatility Index, until last week, had been near record lows in a very complacent market. "Everything started with the Fed last week putting the markets on alert a little bit," said Dan Deming who trades the VIX with Stutland Equities. "The way I characterized it was a change in the barometric pressure. I think that changed the short term weather pattern in the market, and that's why we saw the reaction last week in the VIX."

VIX futures volume shot to an all-time high of 302,278 contracts Monday.

"The market is a little bit jumpy here. It certainly means short-term there are some storm clouds on the horizon, and it's a question of what kind of magnitude the storm is going to be," Deming said.

Stocks were higher in early trading Monday on early optimism about the Italian election, but sold off as the day wore on when it became clear that former Prime Minister Silvio Berlusconi's party took more votes than expected. The euro and risk assets fell sharply, but the steepest declines came after European markets closed so traders were watching to see what further reaction there would be in European debt and stock markets. The euro was at 1.30 for the first time since early January.

(Read More: Italian Election Returns Point to Hung Government)

"Most people thought Berlusconi wasn't in the picture. Now it looks like we could have a hung parliament," said John Briggs, senior Treasury strategist at RBS. The 10-year yield was at its lows at 1.86 percent in late trading, well below the 2.01 percent level it touched in the morning. Briggs pointed out that the 10-year yield had not been more than 5.5 basis points away from the 2 percent level since Jan. 25, and it has now broken down to a new lower range.

"It's pretty amazing, really. Almost everybody came to the conclusion that Europe's politics will be stable…and now we have one the most important countries with 10 percent supporting aggressive austerity, and 25 percent supporting euro exit, and another 26 percent supporting Berlusconi. It's pretty dramatic," said Nordvig. He said it's not yet clear whether there would be a new vote. "I don't think that's a given. There's also a chance they'll try to go with a strange coalition."

Besides Italy and Bernanke, traders are watching housing data in the U.S. The S&P/Case Shiller home prices index, and FHFA home prices are at 9 a.m. ET, while new home sales are at 10 a.m. Consumer confidence is at 10 a.m. The Treasury auctions $35 billion in five-year notes at 1 p.m.

There are also earnings from Home Depot, Macy's, Saks, Tenet Healthcare, Bank of Montreal, AutoZone, Holly Frontier and American Tower, before the ell., First Solar, Papa Johns, TiVo, Range Resources and American Water Works report after the closing bell.