The risk of inflation is why the Fed didn't cut rates for four years. Last week, it finally lowered the target fed 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, "it will continue to monitor inflation developments carefully," however.
Tuesday's rate cut, along with some strong corporate earnings reports, fueled a 2.9 percent rise in the Dow Jones industrial average last week, a 2.8 percent jump in the Standard & Poor's 500 index and a 2.7 percent 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 is now equal to the Canadian dollar for the first time in more than 30 years. A weak dollar benefits U.S. exporters and companies who pull in revenue from overseas, but it can make imports more expensive and dollar assets, like U.S. Treasurys, 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 United States reduce prices to make up for the dollar's fall. But inflation could accelerate, which would prevent the Fed from lowering rates further or even prompt a hike.
The personal consumption expenditures deflator is released in the Labor Department's Friday report on personal spending. The core PCE, which eliminates volatile food and energy prices, is anticipated to show a year-over-year rise of 1.9 percent, 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 percent and 2 percent.
Meanwhile, personal spending in August is expected to have risen by 0.3
percent after increasing by 0.5 percent. Though it's not directly
correlated, investors will try to gauge future spending patterns through
consumer confidence reports from the Conference Board and the University of
Michigan, on Tuesday and Friday, respectively.
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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 Association of Realtors reports on existing home sales
and homebuilder Lennar Corp. releases its quarterly earnings. Later, 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 Wednesday report on August durable goods orders
will be particularly important. Economists are anticipating a 3.1 percent
decline, following a solid 5.9 percent advance in July.
The next day, the Commerce Department releases its final measure of
second-quarter gross domestic product, and Friday, the Chicago purchasing
managers index of September manufacturing activity in the Midwest. The
Chicago PMI 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.
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 percent 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."
[Associated Press; by Madlen Read]
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