NEW YORK (CNNfn) - The main event on Wall Street next week, bar none, is the Federal Reserve's meeting on interest rates -- the first of the year and one in which most investors are expecting another inflation-crunching rate increase. |
For months and months, investors have been waiting for the red-hot economy to spur producers and retailers to raise the prices they charge consumers. Record employment and surging stock market gains have padded Americans' wallets and made them eager to spend, while recovering economies in Asia and Europe have made demand abroad for U.S. goods equally robust.
Yet the prices they pay, with the exception of things like gasoline and heating oil, haven't really budged. In fact, prices for things like computers, wireless phones, DVD players and other products have declined in the last 12 to 18 months. Higher productivity and fierce competition have kept retailers from raising their prices but still allowed them to produce significant profits.
As good as it all sounds, it's the kind of thing that's become cause for concern among Fed policy makers, who gather in Washington next week to discuss the economy. And it's the kind of thing that undoubtedly will lead them to raise short-term rates again in a bid to slow things down and make companies and people think twice about borrowing money.
Stamping out inflation
"If inflation is around the corner, the Fed doesn't want to meet it -- it wants to kill it before it gets around the corner," said Richard Babson, president of Babson-United Investment Advisors in Boston. "The Fed wants to make sure that there are no significant cost pressures in the economy."
Some evidence of accelerating inflation reared its ugly head Friday after the government reported that labor costs rose at a stronger-than-expected pace in the fourth quarter and that inflation -- as measured in the government's report on fourth-quarter growth -- actually showed some signs of acceleration.
The government reports prompted investors on Friday to flee the stock market for the comfort of bonds, sending the Dow industrials to a 289-point loss.
Experts said the market had already factored in a quarter-point hike by the Fed this week. But, based on the strength of the two economic reports Friday, some investors feared the Fed would take a more aggressive stance now.
"One of the things that happened today is the sneaky suspicion that the Fed may raise interest rates by 50 basis points (half a percentage point) instead of the 25 basis points (quarter of a percentage point) because of these economic numbers," Mark Stoeckle, portfolio manager at Liberty-Colonial's U.S. Growth and Income Fund, told CNNfn's Street Sweep.
The reports indicated what analysts and investors have been concerned about for some time: that the robust U.S. job market is finally beginning to spur employers to dish out higher salaries and benefits, and that consumers armed with heftier paychecks and backed by paper gains from the stock market are ready and willing to pay more for goods and services.
"There's absolutely no question that the U.S. economy is on a tear and needs to be slowed," Babson said. That's going to happen with higher interest rates, starting with next week's FOMC meeting, and possibility continuing through the summer months as the Fed taps on the brakes to slow the economy down some more.
A series of moves?
In the past eight months, the Fed has raised rates three times in a bid to moderate the economy and prevent a flare-up in inflation. The last rate rise came Nov. 16 when the FOMC raised its benchmark federal funds rate by a quarter point to 5.5 percent. The rate sets the trend for what banks charge their clients to borrow cash.
And yet the economy has shown few signs of slowing down. Consumer spending is still on a tear. Manufacturing is still on the upswing. Housing, while slower than before, is still strong. And now wages are beginning to creep up.
"One thing is certain: The Fed's tightenings to-date have not stood in the way of an accelerating U.S. economy," said Sherry Cooper, chief economist at brokerage Nesbitt Burns Inc. "The State of the Union is strong indeed."
For months, analysts, investors and several Fed officials, including Chairman Alan Greenspan, have publicly embraced the notion of the "new economy" where rapid gains in technology have made U.S. companies more productive. Higher productivity allows businesses to produce more without dishing out more in expenses, keeping the cost of the final product low.
Prices on the rise?
At the same time, few analysts -- and Greenspan, in particular -- ever wholeheartedly agreed that strong growth without any significant gains in wages or prices could last forever. Most have argued that, eventually, workers will demand higher salaries and retailers will boost prices.
Indeed, some businesses are getting wise to the flow of green pouring out of consumers' pockets. Fast food chain McDonalds Corp. (MCD: Research, Estimates) is expected to lift prices on some of its products in 2000 and introduce new ones that are slightly more expensive. And clothing retailers including the Gap (GPS: Research, Estimates) have either implemented slight increases on some of their new lines or put fewer items on the rack with sale tags -- with little complaint from consumers.
For the most part, though, prices haven't risen very much -- mostly because retailers and producers know that if they raise their prices, consumers will go elsewhere -- whether by walking down the street or logging onto the Internet.
One, two, three?
"There's little doubt out there that Greenspan will move this time around and try to put the brakes on growth a bit," said Michael Gregory, an international economist at Lehman Brothers. "The question is whether this is a one-time deal or a continuation of a series of moves meant to really keep the economy in line."
Of course, the Fed meeting isn't the only event that will grab Wall Street's attention next week. Several economic reports are on the calendar, including December personal income and spending figures, January's National Association of Purchasing Management survey on manufacturing activity, construction spending, new home sales and new car sales.
And once the Fed meeting is over with, investors will turn their sights to more economic reports, including factory orders, the NAPM's non-manufacturing survey and, most notably, Friday's release of January job figures.
Initial public offerings also should grab some of the spotlight next week as the IPO market begins to heat up with new companies. Some highlights will include Alamosa PCS (APCS), which provides digital wireless services in 14 different markets across the U.S. and is affiliated with Sprint Corp. (FON: Research, Estimates). And Swiss Natural Brands (SWIS), which markets a variety of naturally flavored, vitamin-fortified fruit drinks and teas under the Swiss Natural label.