Wall Street to watch for signs of inflation

L.A. Times Archives

Sept. 24, 2007 12 AM PT

From the Associated Press

new york -- Last Tuesday, Wall Street got exactly what it was angling for: a half-point reduction in interest rates. Now it wants to make sure rates will stay low.

This week, investors will be looking for signs that inflation is under control. If prices accelerate, the Federal Reserve may bump rates back up. The market is also hoping that readings on durable goods demand, the housing market and consumer spending power will show that the economy isn’t heading for recession.

The risk of inflation is why the Fed didn’t cut rates for four years. Last week, it finally lowered the key federal funds rate by half a percentage point “to forestall some of the adverse effects on the broader economy” of recent housing, credit and stock market turmoil, and “to promote moderate growth over time.” The Fed added, however, that it would “continue to monitor inflation developments carefully.”

Tuesday’s rate cut, along with some strong corporate earnings reports, fueled a 2.9% rise in the Dow Jones industrial average last week, a 2.8% jump in the Standard & Poor’s 500 index and a 2.7% gain in the Nasdaq composite index.

It also sent gold prices soaring, crude oil to new record heights and the dollar plunging. The U.S. currency reached all-time lows against the euro and hit parity with the Canadian dollar for the first time in more than 30 years. A weak dollar benefits U.S. exporters and companies that pull in revenue from overseas, but it can make imports more expensive and dollar assets, such as U.S. Treasuries, less attractive to foreign investors.

There hasn’t been any evidence yet of import inflation, said Jeff Kleintop, chief market strategist at LPL Financial Services in Boston. He noted that many exporters to the U.S. could reduce prices to make up for the dollar’s fall. But inflation might accelerate, which could prevent the Fed from lowering rates further or even prompt a hike.

The personal consumption expenditures index will be released in the Labor Department’s Friday report on personal spending. The core index, which eliminates volatile food and energy prices, is anticipated to show a year-over-year rise of 1.9%, according to the median estimate of economists surveyed by Thomson Financial.

“If we get a PCE that’s higher than that, it may suggest the Fed acted too aggressively,” Kleintop said. The Fed’s comfort zone is between 1% and 2%.

Meanwhile, personal spending in August is expected to have risen by 0.3%. Though it’s not directly correlated, investors will try to gauge future spending patterns through consumer confidence reports from the Conference Board on Tuesday and the University of Michigan on Friday.

Bad news on the housing front has become a given on Wall Street, but market participants will continue to monitor the industry’s failing health. On Tuesday, the National Assn. of Realtors reports on existing-home sales and home builder Lennar Corp. releases its quarterly earnings. On Thursday, the Commerce Department comes out with its new-home sales data, and KB Home posts its earnings.

Because the market has already priced in a weaker consumer and sluggishness in the housing market, business spending “is the leg of the stool that’s most important to the economy right now,” Kleintop said.

The Commerce Department’s report Wednesday on August durable goods orders will be particularly important. Economists are anticipating a 3.1% decline after a solid 5.9% advance in July.

On Thursday the Commerce Department releases its final measure of second-quarter gross domestic product, and on Friday the Chicago purchasing managers index of September manufacturing activity in the Midwest comes out. The Chicago index is seen as a precursor to next week’s September manufacturing report from the Institute for Supply Management.

Besides economic data, Wall Street will be watching out for profit warnings from companies ahead of October’s flood of third-quarter earnings reports.

Investors are a bit nervous about how corporate America fared during August’s stock market volatility and credit tightness, but they are optimistic at this point, particularly given that international growth is a big source of income for many companies.

About 40% of earnings in the S&P; 500 come from overseas, Kleintop said. “A lot of people think, ‘As goes the economy, as goes the U.S. consumer, so goes corporate earnings.’ That’s not necessarily so.”

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At a glance

Today

Treasury bill auction.

Tuesday

National Assn. of Realtors reports on existing-home sales for August.

Senate hearing on digital television.

House hearing on the safety of food imports.

House hearing on problems in the mortgage industry.

House hearing on rail competition and service.

Conference Board reports its monthly consumer confidence index.

Quarterly earnings reports due from Lennar and Red Hat.