Bets that the Federal Reserve will cut interest rates at Tuesday's policy meeting have boosted stocks of late. The Fed remains the stock market's main focus leading up to the meeting.
The fed funds rate has stood at 5.25 percent since June 2006 as the central bank has sought to balance pricing pressure with the threat of an economic slowdown stemming from the collapse in the housing market.
But the recent rise in mortgage defaults and the credit crunch have convinced investors that the Federal Reserve will have to cut interest rates so as to keep financial markets stable.
The Fed has already cut the discount rate, which affects bank loans, and has injected billions into the banking system to keep liquidity flowing.
But investors are betting the Fed will cut the fed funds rate, which impacts consumer loans, with the debate now about whether the cut will be a quarter- or a half-percentage point.
A quarter-percentage point cut would soothe nervous investors without raising any flags about a possible recession. It would also turn the focus to whether the central bank will cut rates again at its next meeting in late October, said Charles Smith, chief investment officer at Fort Pitt Capital Group.
Anything else could send stocks lower, at least in the short run, he said.
"If they cut a half point, stock market investors are going to think the Fed knows something they don't and that the economy is in worse shape than they realized," he said.
However, should they cut a half, at least investors will think the Fed is done cutting rates for a while and the focus will return to the economy and earnings, he said.
If they don't cut rates at all, stocks could see a big selloff, he said.
Ahead of that, Friday brings the August retail sales report, as well as readings on industrial production and capacity utilization, and consumer sentiment.
Thursday's one economic report of note was the weekly jobless claims report, which showed a smaller-than-expected rise in the number of Americans filing new claims.
