Specter of Fed Is Raising Cain

A rate hike seems virtually certain, and some investors are saying that with a tightening out of the way, stocks could rally.
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The

Fed's

going to raise rates Aug. 24. Now what?

You want the coming week in a nutshell? That was it. For most on Wall Street, the July

employment report

put a nail in it.

Alan

& His Friends are going hiking at the end of the month.

No, it's not a 100% thing. It is possible that recent problems in the swap market will stay the Fed's hand at its next meeting. Or maybe the Fed feels that the bond market is doing its job for it, that higher yields will sufficiently slow the economy down to mitigate any action.

There are some people who are making these arguments. Not many. "I guess nothing's done until it's done, but it sure seems like the Fed is going to raise rates," said Charles Crane, chief market strategist at

Key Asset Management

It is pretty clear that an August tightening of 25 basis points has been priced into the bond market. It's less clear that it's been priced into the stock market -- the naysayers on a rate move seem to be concentrated on the equity side of things. That's too bad. It suggests that there's more downside in stocks.

And even if a hike is fully priced into both markets, they may decline as jittery investors take out insurance for something worse. The doomsayers are out in force. "People are saying, 'Will they go 50 basis points? Will they go between meetings?' The same guys who were saying inflation was dead six months ago are now saying the Fed is behind the curve," grumbled Bob Diclemente, co-head of U.S. economic research at

Salomon Brothers

.

A market that begins to price in a worse scenario than likely is a market asking for a rally. Things may be setting themselves up for a scenario similar to what happened late June, when the market took off like a shot on the rate hike. With a tightening out of the way, after all, many investors would bet that the Fed was done. And there would be a steady drone of talking heads saying there's no way Greenspan would hike rates at the Oct. 5 meeting, for fear of what might happen with

Y2K

. Add to that the perception that this quarter is even better than last for corporate America, and you've got a nice little move to the upside.

"Once we get beyond Aug. 24, investor attention will return to earnings," said Crane. "The third-quarter numbers are going to be pretty good. Comparisons to 1998 will be easy and global economic growth is positive." Industry analysts are predicting earnings growth in the

S&P 500

of 21.4%, according to

First Call

. Although that will probably be revised down, growth in the 20% range is definitely doable.

The immediate concern of investors who believe this rally-on-a-rate-hike scenario is: When will the bottom come? Or, to put it another way, when will the number of people who believe in this scenario overcome the number of people who are nervous about the market going lower?

The next concern is whether any move up in September will be anything more than a trading rally. Much of that will depend on whether the Fed thinks the economy threatens overheating.

"The real question going ahead is if additional rate hikes are necessary," said Bill Sullivan, chief money-market economist at

Morgan Stanley Dean Witter

. "Will they have a dossier of evidence by early October that warrants another increase in the fed-funds target? If evidence builds that suggests that they're going to go to 5.5%, then there will be further downward movement in pricing."

There are a couple of big economic reports in the coming week, and they'll be used to try and get an early read on what's going to happen in October. July

retail sales

comes out on Thursday, and the July

Producer Price Index

hits on Friday. They will be the first figures on demand for a period after the June hike and will help scope out "how resilient demand is going to be," said Diclemente.

In all, it could be an interesting week for the Treasury market. There's the quarterly Treasury auction, which will move the market around a bit as it tries to digest new supply. There are the widening spreads between government and corporate debt, which may continue to shake things up.

Stocks could rock and roll a bit too. Besides keeping an eye on that jumpy bond market, any declines in the Internets could prompt more worries about margin calls -- and more talk about how the pain in the dot-coms will inevitably spill over to other areas.

"I think the one ingredient we can count on," said Crane, "is continued volatility."

Better stock up on that Dramamine.