Mrs. Phelps watches Matilda with surprise and excitement because she is amazed by Matilda's intelligence and talent. Matilda is able to read and understand complex books at a very young age, which is something that Mrs. Phelps finds impressive and inspiring. Additionally, Matilda's love for reading and storytelling resonates with Mrs. Phelps, who also enjoys literature and storytelling. Overall, Mrs. Phelps is excited to see a young girl with such a passion for learning and knowledge.