Gearing up for the Fed

NEW YORK (CNNMoney.com) -- Investors hoping that early 2007 brings both a so-called "soft landing" for the economy and lower interest rates could be disappointed after Tuesday's Fed policy meeting.

That doesn't mean these things won't happen next year. It's just that most analysts expect the Federal Reserve to hold interest rates steady for the fourth time in a row and to continue to trumpet the threat of inflation over the threat of recession.

In other words, if the Fed is thinking it might cut rates early next year, it isn't likely to tell the markets Tuesday. (Full story)

"The financial markets have recognized that the Fed's inflation concerns haven't panned out," said Michael Strauss, chief economist at Commonfund. He said that this has been suggested in recent reads on core inflation, labor costs and the inflation component of the recent November jobs report.

In addition, other reports - such as Friday's employment report - have suggested that maybe the economy is not slowing as rapidly as had been feared.

All of which raises the question of whether "we get a glimmer of a hint that the Fed recognizes this," Strauss said.

He said he doesn't think the Fed will be as forthcoming as the recent data have been.

"I would be extremely surprised to see any change in the language," said Michael Swanson, senior economist at Wells Fargo.

How stock investors will react is a matter of some debate.

Stocks have been more or less on the rise since late July, with no big hiccup until the end of November, when a barrage of discouraging readings on housing and the manufacturing sector sent stocks lower.

Yet the recent economic news has been more good than bad, allowing stocks to resume their upward move.

Year to date, the Dow Jones Industrial average (Charts) is up 14.6 percent, the S&P 500 (Charts) index is up 12.7 percent, the Nasdaq composite (Charts) is up 10.1 percent and the Russell 2000 (up 0.27 to 792.56, Charts) is up 17.7 percent.

"Until a few weeks ago, stock investors were looking for a drop in interest rates sometime in the first quarter of 2007," said Chris Johnson, chief investment officer at Johnson Research Group.

Johnson said that recent stronger readings on the economy have lowered expectations of an interest rate cut as soon as the first quarter. In addition, Fed chair Ben Bernanke said as recently as last week that he was worried about inflationary pressures.

Nonetheless, "some of the rally this year has been about expectations for rate cuts," Johnson said. So should the Fed meeting fail to hint at that, "we could see some selling."

Alternately, with the mood on Wall Street still so upbeat - even after four months of gains - investors may not take the news too badly.

"I think the fog will start clearing in the first quarter and we'll begin to see whether the economy is headed for a soft or hard landing," said Hugh Moore, founder and partner at Guerite Advisors.

But for the time being, "the optimism in the market is such that stocks can probably keep rising through the end of the year," Moore added.

In addition to the Fed meeting, next week also brings a slew of other economic news that's "mostly about inflation and consumer spending," said Swanson.

The reports cover retail sales, consumer prices, business inventories and the trade balance, among others. (See chart for details).

Additionally, a trio of brokerages report quarterly earnings, including Goldman Sachs (Charts). Best Buy (Charts) and Adobe Systems (Charts) issue their results as well. (See chart for details).

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