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The market's conundrum
Worries about inflation and interest rates unnerved last week. Next week brings similar concerns.
February 20, 2005: 11:43 AM EST
By Alexandra Twin, CNN/Money Staff Writer

NEW YORK (CNN/Money) - Judging from the reaction in the stock and bond markets last week, it's pretty clear the financial markets are not going to be content to take a ho-hum response to inflation indicators anymore.

And next week brings a few, in particular the read on consumer prices (CPI) in January, due Wednesday.

Comments from Federal Reserve chairman Alan Greenspan to panels in the Senate and House last Wednesday and Thursday paired with a surprise surge in the core component of the producer prices index (PPI) in February proved a fairly toxic combination.

Greenspan noted that the economy was strong and that short-term interest rates would still need to rise. Not exactly surprising to the markets. But then a report Friday showed that the "core" PPI, which strips out volatile food and energy prices, jumped 0.8 percent in January, the biggest monthly gain in six years. Economists thought it would rise just 0.2 percent.

The fact that the "core" PPI showed such a rise was particularly worrisome to investors, as it seemed to counter the belief held by many inflation watchers that the surge in oil prices was what was responsible for any signs of inflation.

Granted, it was just one month's reading and not necessarily an indication that the Fed will now need to raise rates as a faster than expected pace, but it was enough to spook investors last week, and is likely to continue to do so in the weeks ahead.

"Clearly, the focus going forward is going to stay on the macro news to either enforce or dispel the notion that inflation is rising," said Ned Riley, chairman and chief investment officer at Riley Asset Management.

Greenspan's much-discussed "conundrum" as to why yields on long-term bonds have not risen despite the rise in short-term interest rate certainly woke up the bond market: Treasury bond prices tumbled for three sessions, pushing the yield on the 10-year note up to 4.26 percent from 4.08 percent. Treasury prices and yields move in opposite directions.

"What unnerved the market the most and will continue to keep moving it was Greenspan's comments about the treasury market," Riley added. "The comments basically took a lot of financial stocks off guard, all the banks and brokers. That paired with PPI created a bit of a panic."

The three major stock indexes tumbled for the week, with the Nasdaq getting hit the hardest.

"I think Greenspan basically said the obvious, that long rates are too low and against his desire for the economy to grow" said Ben Halliburton, chief investment officer and founder, Tradition Capital Management, "His comments indicated that the Fed will remain in a tightening stance and that we should see further raising as the year progresses."

U.S. financial markets are closed Monday in observance of President's Day. Tuesday brings a read on consumer confidence and earnings from Home Depot. (For a preview of next week's big economic events, click here, for next week's earnings, click here.)

One positive for the stock market next week is that should the main economic event of the week -- the CPI on Wednesday -- show a big jump, at least investors won't be as surprised as they were with PPI last week

And the fact that a lot of money remains on the sidelines is another positive for stocks in the weeks ahead, Halliburton added.

Key events in the week ahead

  • The February read on consumer confidence is due Tuesday from the Conference Board. The index likely showed little movement, rising to 103.5 in the month, from 103.4 last month, according to a consensus of economists surveyed by
  • The consumer prices index for January is due Wednesday. CPI and so-called "core" CPI, which excludes volatile food and energy prices, are both expected to have risen 0.2 percent. In December, CPI fell 0.1 percent while core CPI rose 0.2 percent.
  • The Federal Reserve releases the minutes from its most recent monetary policy-setting meeting on Wednesday. The minutes may provide further insight into the central bank's stand on short-term interest rates.
  • The government's report on durable goods orders for January is due Thursday. Orders are expected to be unchanged in January, after rising 0.6 percent in December.
  • The revised reading on gross domestic product growth in the fourth quarter is due Friday. GDP is expected to have grown at a 3.5 percent annualized rate, versus an earlier read of 3.1 percent. GDP increased at a 4.0 percent rate in the third quarter.
  • January existing home sales are also due Friday. Sales are expected to have risen to a 6.75 million unit annual rate in the month, down from a 6.69 million unit annual rate in December.

Earnings to watch

  • Home Depot (Research) is due to report results Tuesday morning. The Dow component is expected to have earned 47 cents per share, according to First Call estimates, up from 42 cents a year ago.
  • Fellow home improvement retailer Lowe's (Research) is due to report Wednesday before the bell. The company likely earned 59 cents per share, up from 50 cents a year ago.
  • Homebuilder Toll Brothers (Research), which also reports results Wednesday morning, is expected to have earned $1.15 per share, up from 62 cents a year ago, reflecting the still-strong housing market.
  • Viacom (Research) is due to report Thursday morning. The entertainment company is expected to have earned 39 cents per share, according to analysts' estimates, up from 36 cents a year ago.
  • Clear Channel (Research) reports Friday morning. The media company is expected to have earned 37 cents per share, up from 30 cents a year ago.
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