Markets Keep Eye on Europe, but Hopes Rest on Fed

With Spain on the boil and world leaders meeting, US stocks could tread water again Tuesday as the Fed starts its two-day meeting.

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“It’s the only thing keeping us (stocks) elevated here,” said Miller Tabak strategist Peter Boockvar, of the Fed meeting. “Fundamentally, the market belongs much lower, but everybody thinks the Fed’s extending Operation Twist or will pull something else out of its hat.”

In Operation Twist, the Fed has been selling shorter dated Treasurys while buying the same amount of longer dated securities in a bid to keep interest rates low. Many analysts believe the Fed Wednesday could extend the program, while it watches developments in Europe and the state of the U.S. economy.

“I think the Fed probably wants to do a little something, and that little something probably is extending its Operation Twist instead of it expiring at the end of this month. But largely, the Fed is going to want to keep its powder dry ,” said Larry Kantor, managing director and head of research at Barclays.

Stocks Mondaywere mixed, with the technology driven Nasdaq up 0.8 percent, or 22 points to 2895, and the S&P 500 up almost 2 points to 1344.

Applewas a standout on the Nasdaq, rising 2 percent on the day after it broke above its 50-day moving average, at $578.

The Dow fell 25 points to 12,741, pulled lower by Hewlett Packard , Alcoa and bank stocks JPMorgan and Bank of America .

“The rally lasts until the Fed’s done and we see what the Supreme Court says about health care because that has implications for the election,” said Boockvar.

The Supreme Court is expected to rule this month on President Obama’s health care program, and if it is overturned traders believe that could help GOP candidate Mitt Romney, who is the favored candidate of many on Wall Street.

Expectations are low for the G-20 meeting in Mexico, where leaders were expected to be leaning on European officials to take stronger actions to stem the sovereign crisis. The meeting ends Tuesday, and early news reports indicate the G-20 communique will mention a euro zone banking union and assurances that Greece should stay in the euro.

“They’re obviously going to pressure European officials, especially Germany,” Kantor said. “I don’t think that’s going to do much. I think there’s probably more scope for something to come out of the EU summit at the end of the month and even before the EU summit, when the leaders of the four biggest countries meet.”

German Chancellor Angela Merkel Monday stated that there should be no post-election loosening of reform pledges for Greece. There had been hope Germany and the euro zone would relax some of the requirements for Greece, to draw out payments and make austerity measures less severe.

As Greece’s election Sunday resulted in a win by the pro-bailout New Democracy party, markets Monday moved on to focus on Spain. Yields on the Spanish 10-year jumped to a post euro high – above 7.2 percent, raising the countries borrowing costs and concerns it too may need more bailout funds.

Traders will be watching as Spain auctions between 2 and 3 billion euros in 12- and 18-month debt on Tuesday, and another billion or two in longer dated bonds Thursday. Spain last week was promised 100 billion euros to bail out its banks, and it awaits the results of an independent study this week to show the amount of capital required to shore up its banking system.

The euro slipped about a half percent to about 1.2570 in U.S. trading Monday, wiping out gains made earlier on the results of the Greek election.

Markets had traded higher at the end of last week, as traders bet the New Democracy party would succeed. After results were announced, U.S. stock futures rallied overnight, along with global equities markets, but those early gains were reversed.

“In a way, the crisis keeps intensifying in the sense that each policy response to the flare up in the crisis seems to have to be bigger just to stabilize things and a time period where a new bout of volatility springs up tends to be shorter. The markets are showing an impatience,” said Kantor.

Mark McCormick, currency strategist at Brown Brothers Harriman, said the markets are looking for some language from the G-20 supporting a tighter union in Europe. “The script has to be a focus on a banking union, maybe some level of deposit insurance. I think the markets want a step toward political and fiscal union,” he said.

“It’s likely the markets will be disappointed because they have been disappointed by most of the summit results,” he said.

Kantor said there could also be comments on a common bond. “What we really need is something more permanent like a change in the structure of the euro area, a fiscal framework and banking regulation with deposit insurance,” he said.

What Else to Watch

J.P. Morgan CEO Jamie Dimon returns to Capitol Hill Tuesday at 9:30 a.m. ET to testify on the bank’s trading losses before the House Financial Services committee. There is also housing starts data at 8:30 a.m. ET, and Jefferies Group , FedEx and Discover Financial report earnings before the opening bell.

Adobe and Jabil Circuit report earnings after the closing bell.

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