Stocks Close In on Highs, but Watch Out for Rising Rates

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Wall Street's bulls are sniffing out new highs.

With the small cap Russell 2000 hitting record levels for a third day Tuesday, traders are watching to see if the S&P 500 and Dow will follow it. The Dow, at Tuesday's close was within striking distance of its all-time closing high, just 109 points from 15,409 reached on May 28, and the S&P was just 1 percent away from the high it set on May 21, of 1,669.

"I didn't think it would get there this quickly, but it sure seems like it might make it," said Randy Frederick, managing director of active trading and derivatives at Charles Schwab.

Stocks Wednesday were fluctuating in a narrow range, but lost some steam as rates began rising ahead of the Treasury's 1 p.m. EDT $21 billion 10-year auction.

"As we keep an eye on yields in the 10-year, it's going to keep being a factor in equities trading, especially as we get near resistance," said Art Hogan of Lazard Capital Markets. The S&P 500 was struggling to break resistance at 1,650, he said.

But if it can close above that level, the highs are not that far away.

"The key is (Dow) 15,340," said Paul LaRosa, chief market technician at Maxim Group. "If we close above that, the highs are in sight." The Dow closed up 75 points Tuesday, at 15,300, and the S&P 500 closed at 1,652, up 11. The number he is watching in the S&P 500, is 1,654, Tuesday's intraday high, and if it closes above that level, he expects to see new highs.

"It feels like we could get there and a lot of the technology names are looking pretty good, some of the regional banks look good," said LaRosa. "The consumer companies led it early on and now they're treading water while technology, banks and special situations have been powering this rally lately. … Retailers are one group that's been strong."

LaRosa said the two big threats to the rally are interest rates and earnings. Treasury yields were higher Wednesday, with the 10-year yield at 2.65 percent, up from Tuesday's 2.63 percent. The 10-year yield hit a high of 2.73 percent hit Friday, well above its early May low of 1.62 percent.

"There's some selling in the mortgage market. Mortgages are underperforming and we're getting ready for the auction," said John Briggs, senior Treasury strategist at RBS, of the move higher in yields.

"After the auction, you have the minutes at 2 and Bernanke at 4 so this is the path of least resistance," he said.

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The minutes from the Fed's June meeting are released at 2 p.m. EDT. Traders expect to see some of the behind-the-scenes discussion that led Fed Chairman Ben Bernanke to announce that the Fed could cut back its quantitative easing program before the end of the year.

Bernanke speaks at 4:10 p.m. from the National Bureau of Economic Research conference. His topic is "The First 100 Years: A Century of U.S. Central Banking: Goals, Frameworks, Accountability."

"There's concern that the last three times Bernanke's given a speech, the Bernanke effect has not been positive for equities," said Hogan. "That's a largely academic speech but he's going to take questions."

LaRosa said the longer term trend for yields is higher, but they may not make much headway for now.

"My feeling is rates will come lower before they head higher, but it's a good trend. It looks like higher yields are here to come, but I do think the 10-year could pull back to 2.25 but I would use that as an opportunity to sell rather than buy," said LaRosa. He said Bernanke's comments and the Fed's last meeting were the big catalysts for the recent rate move. "People will look at it, but these minutes are from before the employment report. I think people are resolved that the Fed is going to taper in September."

The strength of Friday's June jobs report further shifted the view on Wall Street that the Fed could start to wind down its $85 billion in monthly bond purchases as early as September. Despite that, stocks have been in rally mode since Friday.

"The market decided on Friday that good news is good news. That's a fundamental shift that frankly all of us involved in this industry are happy to see," said Frederick. There were 195,000 nonfarm payrolls added in June, but revisions for April and May took the six month average to about 202,000.

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Brian Edmonds, head of interest rates at Cantor Fitzgerald, said he expects the auction to go well. "We saw what may be, at least shorter term, the high yields that we're going to see for a while," said Edmonds.

"There's no reason to think Bernanke is going to be showing his hand right now," he added. But traders will still monitor his comments, especially in the question and answer period following the speech.

After the close, Chevron gives an interim update on its results and Yum Brands reports earnings.

—By Patti Domm, CNBC executive news editor. Follow her on Twitter @pattidomm.