Fed policy makers favor keeping interest rates near zero for a long time to nurture the recovery from the worst recession since the 1930’s. The consumer-price report showing consumer prices rising 0.2 per cent in September, after a 0.4 per cent gain in August supports this policy decision.

Mark Vitner, a senior economist at Wells Fargo Securities LLC, North Carolina said “the economy still has a tremendous amount of slack and the low inflation numbers we are likely to see will give policy makers the flexibility to take their time in raising rates.”

Fed Vice Chairman Donald Kohn this week said that inflation and growth will probably stay below the central bank’s objectives for some time, warranting low interest rates for an “extended period.” New York Fed President William Dudley echoed the same opinion.

With a different view are Kansas City Fed President Thomas Hoenig and Fed Governor Kevin Marsh, who have both been among those saying that rate increases may happen sooner, or with more force, than some investors anticipate.

The message to investors is that corporate America feels good enough about the recovery and finds that it is time to expand. Initial public stock offerings have risen recently as these positive signs of merger activity indicates that the financial system is normalizing.

The third quarter is winding down, and analysts believe that stocks most probably will get a lift, as mutual funds buy the best performing stocks to dress up their portfolio. in time for their quarterly performance statements.

Technology stocks lead the up swing on Monday on news that Xerox would pay $6.4 billion to buy Affiliated Computer Services. Affiliated stock rose nearly 15 percent, as Xerox shares dipped slightly.

The Labor Department releases its monthly employment report on Friday, with economists predicting the unemployment rate climbing to 9.8 percent from 9.7 percent, even as the number of payroll job losses slows. Investors will get more information on the housing market this week with the release of the Case-Shiller Home Price Index on Tuesday.

Five of twelve districts reported signs of improvement, according to the central bank’s Beige Book, while encouraging signals were seen in manufacturing. Consumer sales remaineded weak, which was due to softness still lingering in labor markets.

The Dow Jones industrial average had advanced 34 points and the Nasdaq lead the session, advancing 19 points. Commodity prices were rising as OPEC members were gathering for their latest meeting. A weaker dollar helped fuel the advance, as the Euro rose to $1.451, from $1.4499 late Tuesday.

There was a slide in treasury prices after a $20 billion dollar auction of 10-year notes drew decent demand, and its yield inched up to 3.50%.

Stocks traded higher when the market was boosted by a 1.4% month-over-month rise in both the 10- and 20-city S&P/Case-Shiller home-price indexes for June; also, the Conference Board’s August consumer confidence index rose to 54.1 from 47.4 in July. News that President Barack Obama will nominate Ben Bernanke to a second term as Federal Reserve chairman also lifted sentiment.

On Tuesday at 10:21 a.m. ET, the 30-stock Dow Jones industrial average was higher by 39.60 points, or 0.42%, at 9,548.88. The broad Standard & Poor’s 500-stock index was up 2.98 points, or 0.29%, at 1,028.55. The tech-heavy Nasdaq composite index gained 6.76 points, or 0.33%, to 2,024.74. Treasuries were lower in price before a $42 billion auction of two-year notes Tuesday afternoon. The dollar index was lower. Gold and silver futures were higher. Crude oil futures were higher in volatile trading. In company news Tuesday, home improvement retailerLowe’s Companies (LOW) announced a joint venture with Woolworths of Australia.

Citigroup (C) reportedly accelerated its efforts to modify mortgages on its books.

Shares of Burger King (BKC) rose after the company reported a 16% gain in net profits.

Shares of automakers slipped as the “cash-for-clunkers” program came to an end.

The U.S. mid-session budget review released Tuesday showed the expected reduction in the fiscal 2009 budget deficit, but a steep increase in the cumulative deficit out ten years. The current red ink amount for the year is now estimated at $1.58 trillion, as was leaked last week. And also as indicated by press reports, the cumulative deficit is projected at $9.05 trillion through fiscal 2019. One significant revision to the economic assumptions is an increase in the unemployment rate to 10% by the end of the year, while averaging 9.3% for 2009. Previously the administration saw a peak at 9.4% later this year. GDP growth is predicted at 2.0% for 2010. The CPI is expected to contract 0.7% this year. Meanwhile, the Congressional Budget Office projects a $1.6 trillion deficit this fiscal year, and a $1.4 trillion short fall in fiscal 2010. The cumulative 10 year budget deficit is estimated at $7.1 trillion . The economy is expected to grow at a 2.8% pace next year, and 3.8% in 2011. The unemployment rate is projected to average 10.2% next year.

Obama’s decision to renominate Bernanke shows that the President has opted for continuity in U.S. economic policy despite criticism in Congress of the low-key central banker’s frantic efforts to rescue the financial system, according to press reports. Bernanke is seen by supporters inside the administration and in markets as a creative and steady hand who helped to keep the financial chaos, which became especially dangerous in the past year, from becoming much worse. Former Fed Chairman Paul Volcker said money-market mutual funds undermine the strength of the U.S. financial system and should be regulated more like banks, according to a Bloomberg News report. “Banks remain the functioning heart of the financial system, and they are protected and regulated,” Volcker said. “To the extent they have competitors that have different ground rules, kind of free-riders in my view, weakens the financial system.”

The next big task facing these central bankers will be how to unwind the vast emergency measures that were put in place to fight the crisis. After the anxiety and tension that permeated their retreat one year ago the mood of relief and cautious confidence was almost palpable.

Housing news provided an additional lift, as the National Association of Realtors reported that sales of existing homes jumped 7.2 per cent in July. Bernanke did temper the mood by warning that the economic recovery was very likely to be slow and arduous, and that unemployment would remain high for another year. A growing number of economists and some Fed officials say that the shift to tighter monetary policies and higher interest rates will have to be much more abrupt than normal to prevent inflation in two or three years.

Mr. Bernanke did caution that strains persist in many financial markets across the globe, and he acknowledged that the banking system’s problems were far from over. This was echoed by Jean-Claude Trichet, president of the European Central Bank, who said “We still have a lot of work to do,” adding that “it would be a catastrophe if governments failed to heed the lessons of the crisis and financial regulation.”

The easing of the recession put Europe and the United States roughly on a par with each other, with the United States’ economy shrinking at an annual pace, in the second quarter, of 1 per cent to Europe’s 1.2 per cent. However, economists see a difference in recoveries next year, with the U.S. bouncing back more quickly than Europe. Lagging efforts to repair a damaged banking system in key countries like Germany, plus rising unemployment are keys to the negative outlook over the remainder of the year.

The International Monetary Fund has criticized European countries for not moving quickly enough to recapitalize banks and clean balance sheets of bad assets, although it may be healing faster than expected.

The European Central Bank, on the other hand,  optimistically projects lower losses than the I.M.F, suggesting a banking recovery is under way. Recent data suggests credit flows are easing, despite individual countries reporting problems with longer-term loans.

Investors scooped up financial, technology and other shares knocked down in a two-day selloff. Gains were broad-based, with 27 of 30 Dow components rising. Stocks slipped Monday and Tuesday, with bank shares leading the selloff, as investors backed off in anticipation of the Fed meeting. Investors were also retreating in the aftermath of a big rally. With the exception of a pullback in late June, the S&P 500 has basically been on the rise for five months. Since bottoming in early March, the index has gained 50% through the end of last week.

Federal Reserve meeting: The central bank concludes its two-day policy meeting Wednesday with an announcement expected at around 2:15 p.m. ET. The Fed is expected to hold rates steady at historic lows near zero percent. In the closely-watched statement, the bankers are likely to say that they see economic activity picking up, but remain cautious about the outlook. The Fed is not expected to say much about what its exit strategy may be after putting so much stimulus into the financial system.

Economy: The trade gap widened to $27 billion in June, the Commerce Department reported. The deficit stood at $26 billion in May, a 10-year low. The deficit was expected to widen to $28.7 billion in June, according to a consensus of economists surveyed by Briefing.com.

The Treasury budget is also on tap for Wednesday afternoon.

Company news: After the close Tuesday, Applied Materials (AMAT, Fortune 500) reported a fiscal third-quarter loss versus a profit a year ago on weaker revenue. However, the results were better than what analysts were expecting. The chipmaker also said it would at least break even in the fiscal fourth quarter and potentially post a profit of up to 4 cents per share. Analysts expect the company to post a loss of 5 cents per share. AMAT shares gained 4% Wednesday.

Bonds: Treasury prices inched higher, lowering the yield on the benchmark 10-year note to 3.65% from 3.67% late Tuesday. Treasury prices and yields move in opposite directions.

The government is auctioning $75 billion in debt this week as part of its efforts to reduce the deficit and fuel its recovery efforts. Treasury’s Tuesday auction of $37 billion in three-year notes saw stronger demand than other recent auctions. On Wednesday, the government auctions $23 billion in 10-year notes, with results expected around 1:00 p.m. ET. On Friday, it sells $15 billion in 30-year bonds.

Oil and gold: U.S. light crude oil for September delivery rose $1.40 to $70.85 a barrel on the New York Mercantile Exchange.

COMEX gold for December delivery rose $2.70 to $950.30 an ounce.

Other markets: In global trading, European markets rallied in the afternoon. Asian markets tumbled.

This was the biggest market drop since early July, caused mostly by fears that the job cuts could pose additional threats to household finances, consumer spending and families’ abilities to make ends meet.

The government will report first-time jobless claims on Thursday, and release its monthly assessment of the labor market on Friday. Economists expect that the report will not be favorable, estimating a loss of 328,000 jobs in July, after a loss of 476,000 jobs in June.

P&G will aim to sell more beauty products in drug stores. It is also aiming to increase its overall presence online. The company will put more focus on lower priced products but will continue to grow its higher margin businesses through internal growth and acquisitions, he said. P&G expects to benefit in coming quarters from moderating commodity costs and investments made to grow its brands.

On the call, company executives said the consumer products giant will continue to face “headwinds” in the first quarter, but that some those pressures will ease as the year progresses. The company said its share repurchases for fiscal 2010 may be below its previously estimated $8 billionthreshold for the year. P&G shares were recently down 3.4% to $53.59.

The first round of the strategic and economic dialogues, which will be held on July 27-78 in Washington, is a reincarnation in a broader format of the Strategic Economic Dialogue set up by former US Treasury Secretary Henry Paulson, who used the forum to engage Beijing on an array of issues critical to longer-term bilateral relations. The new mechanism was jointly launched by Chinese President Hu Jintao and his US counterpart Barack Obama during their meeting in London in April. 

On the US side, the dialogues will be headed by Secretary of State Hillary Clinton and Secretary of the Treasury Timothy Geithner.   According to Chinese Foreign Ministry, Dai and Clinton will co- chair the “Strategic Track” of the dialogue, while Wang and Geithner will co-chair the “Economic Track.”Obama will address the opening session of the dialogue, and meet with the Chinese delegation after the dialogue. During the meetings, the two sides will have extensive discussions on issues of strategic, overall and long-term significance in order to “deepen understanding, enhance mutual trust and promote cooperation,” said a Chinese Foreign Ministry spokesman at a press conference earlier this month.   

According to a Chinese finance official, China will explicitly raise at the “Economic Track” dialogue the hope that the United States “should make responsible economic policies, including financial and monetary policies, to maintain stability of the dollar and safeguard safety of China’s assets.”On the agenda of the “Strategic Track” dialogues, Chinese Foreign Ministry has said that the two sides would discuss the resumption of the six-party talks on the Korean Peninsula nuclear issue for a peaceful resolution.