The Coming Week: Few Players in Attendance for FOMC Meeting Could Make For Volatility

The dollar will be the other focus, displaying a limpness that has dampened the market.
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If the

Fed

hikes interest rates, and everybody's at the beach, does it make a sound?

In the coming week, Wall Street will come awful close to answering that question (first posed, we think, by the

Bishop Berkeley

). A lot of trading desks will be empty when the

Federal Open Market Committee

meets on Tuesday.

"I've been talking to whatever clients I can find, and everybody is talking about how they'll be off to the Hamptons or off to Nantucket. I myself won't be here," said Jeffrey Applegate, chief strategist at

Lehman Brothers

. "There aren't going to be a lot of players."

Yet while a complete absence of players would bring silence, a relative lack could make for heck of a lot of noise. When volume thins, markets get volatile. Whichever way markets react to the Fed decision could be exaggerated.

This is not to say that people aren't pretty much of the same mind on what the FOMC is going to do. Just about every serious economist on the Street says the committee will hike the fed funds target rate by a quarter point to 5.25%. "Nothing is a foregone conclusion," says Don Fine, chief market analyst at

Chase Asset Management

, "but I'm hard pressed to come up with a reason they shouldn't go."

But on the margins, there may be some speculation that the Fed will not go, and this could make for a negative reaction. In the stock market, at least, a lot of play has been given to both a report said to have come out of advisory firm

Johnson-Smick

(Johnson being former Fed Vice Chairman

Manuel Johnson

) giving a 25% chance of no hike, and an article by

The Washington Post's

John Berry on Friday suggesting a hike isn't entirely certain. Berry is thought to be close to Greenspan, but the article is clearly not sourced by anyone at the Fed.

Left to its own devices, then, the stock market might have a negative reaction to the announcement of a quarter-point hike. Fortunately for the equity market, stock traders will likely key their reactions to the Fed off the bond market. And the bond market carries no illusions that the Fed isn't going to go. Its recent move up has been more a matter of relief on the heels of the benign

Producer Price Index

and

Consumer Price Index

, which suggested that this may be the last tightening.

"What we have done is eliminated any allowance of tightening in excess of a quarter point," said Kevin Flanagan, money-market economist at

Morgan Stanley Dean Witter

. "The feeling now is that they don't need to be as aggressive as we thought earlier in the month."

This may mean that the bond and stock markets will be able to leg higher on the Fed meeting -- a repeat of what happened in June. It could set up the market for a bit of a rude awakening if the August

employment report

comes in strong. But that doesn't come out for a whole other week.

The other focus will be the dollar, the recent weakness of which has thrown a damper on the stock market. The worry is that the money that for two years flowed into the U.S. stock market while other economies suffered is beginning to ebb away.

Lehman's Applegate is not putting too much stock in the notion that good foreign stock markets will hurt the U.S.

"I hear that argument a lot," he said. "You know we tested that proposition and if you look at when U.S. demand for non-U.S. equity rises, you know what happens most of the time? U.S. stock market goes up." When people like stocks, they like stocks. Go figure.

The notion that the dollar's drop is a negative for U.S. stocks is also something of a stretch in this particular case, says

J.P. Morgan

chief U.S. economist Bruce Kasman. "I would argue most of the dynamic we've seen in the dollar is a good thing," he said. "It's a reflection of a recovery" from the economic crises of the last couple of years.

A weak dollar would be a problem if it weren't coming just from a recovery abroad, but from real problems with the U.S. In that case, there really might be the run for the exits some people have been worrying about. But if the U.S. economy were a mess, it would be a problem for stocks in any case.

"The dynamic of U.S. equity markets and U.S. assets is going to depend more on the fundamentals here," says Kasman. "The issue around capital flows is a second-order one."