What a Week: Hard Sell

Federal Reserve chairman Ben Bernanke and other Fed presidents seem to agree. Repeatedly this week, Fed officials reminded investors this week that inflation remains "uncomfortably high," as if attempting to pull back the Treasury bond market from expecting an ease in the first part of 2007.

The week's data leaned heavier on the negative growth prospects, but did support some concerns about inflation. Even in the Institute of Supply Management report, which read 49.5 (any reading below 50 reveals a contraction), the prices-paid index was higher than expected, revealing some inflationary pressure still in the mix. Likewise, the core personal consumption expenditures deflator came out higher than expected, leaving core inflation at 2.36% year over year -- above the Fed's 1% to 2% comfort zone.

Bernanke spoke again Friday, but did not comment on monetary policy. Chicago Fed President Michael Moskow did comment, however, ignoring the weak ISM report and hinting at further rate hikes. "Some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time," says Moskow.

Philadelphia Fed President Charles Plosser also spoke Friday and reportedly downplayed the ISM report in comments to reporters. Plosser said he is more concerned about inflation than economic growth, according to newswire reports.

So, either the bond market is ahead of the Fed in pricing in a deep economic fall, the Fed doesn't see the same doom and gloom, or the Fed just isn't ready to signal a rate cut yet.

"The Fed is in a bind," says Ethan Harris, chief economist at Lehman Brothers, harkening back to 1995 when the Fed overshot its tightening campaign and had to cut rates later. But in 1995, the economy was slowing more rapidly than it is now, writes Harris. So with history as a guide, the Fed would need to see much slower growth and an abating of inflation pressures to contemplate a rate cut.

Regardless, the fed funds futures market is pricing in 31% odds of a cut in January, up from 14% on Thursday, according to Millrr Tabak. For March, odds of a cut are 70%, up from 40% Thursday. The market prices in a 31% chance of a second rate cut in May.

"The decisive moment for the Fed-bond market tug-o'-war may not come until late winter, when evidence begins to accumulate one way or the other about a reversion toward trend growth or a deepening slowdown," writes Neal Soss, economist at Credit Suisse.

So into December we go, with the markets expecting a hard landing for the economy and the Fed still preaching soft landing and warning of rate hikes.

1 What would best describe your stance heading into the coming week of trading? Bullish Bearish Neutral 2 Which of these sectors do you think is set to move up in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities 3 Which of these sectors do you think is set to move down in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities View the results without voting