The stock market is coming to grips with new worries about inflation that threatens to keep the mood cautious, analysts say. The latest hawkish comments from Federal Reserve chairman Ben Bernanke and his colleagues have taken markets by surprise after a long period of worry about economic weakness.
Now, some traders fear a boost in interest rates is on the way in the near future, even though, the US economy is still sputtering.
The past week saw volatile trade on Wall Street with the main indexes mixed. The Dow Jones Industrial Average of 30 blue chip shares rose 0.79 percent in the week to Friday to 12,307.35 while the Standard and Poor's 500 broad-market index was essentially flat for the week at 1,360.03.
The tech-heavy Nasdaq composite fell at 0.81 percent on the week to 2,454.50. Bernanke signalled in the past week that he would work to keep price expectations in check to avert the kind of inflation spiral that central banks fear.
But he also said that, "the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so." Some analysts say Bernanke is trying to "jawbone" the market to keep inflation expectations in check without actually boosting rates.
Douglas Porter, economist at BMO Capital Markets, said in a note to clients that the market is coming to grips with a "profound shift in focus from weak growth (the frying pan) to rising inflation (the fire) among both global policymakers and markets." A sharp jump in retail sales in May meanwhile, helped ease fears about a consumer meltdown. Sales were up 1.0 percent as Americans boosted spending with the help of tax rebates from the government's economic stimulus.
But Ethan Harris at Lehman Brothers said he does not believe the Fed is ready to start hiking interest rates.
"Hawkish Fed commentary combined with further evidence that the economy is avoiding a major recession has caused a re-pricing of Fed expectations in the markets," he said. "We believe any hike should be seen as a gesture to the markets rather than the start of a sustained tightening cycle. We continue to believe the Fed is more likely to cut than raise rates early next year."
Philip Orlando at Federated Investors said the stock market may be able to make headway despite the muddled outlook.
"We believe that the economic environment is much more stable, earnings visibility has improved somewhat for stocks, the political environment is less uncertain now," he said. "As we look across the valley into the second half of 2008 and 2009, we believe that the combination of depressed valuation levels for these stocks and sectors and the prospect for improved economic activity make this a potentially propitious time to begin to sift through the rubble," for beaten-down shares, he said.
Fred Dickson at DA Davidson & Co said Bernanke has managed to boost the dollar, which is good for the market.
"The implications of a strengthening dollar are very positive for the economy annd the stock market," he said "A strengthening dollar should relieve price pressure on crude oil as crude oil is priced in dollars around the world."
Bonds fell sharply in the past week amid the renewed focus on inflation. The yield on the 10-year Treasury bond jumped sharply to 4.261 percent from 3.938 percent a week earlier and that on the 30-year bond increased to 4.802 percent from 4.650 percent. Yields and prices move in opposite directions.