It's been just a few days since the

Fed

last lowered rates, and most forecasters believe there's at least one more cut to come. But already the market is trying to reckon when the Fed will reverse course and resume tightening.

For the equity market, this could pose a problem. Stocks have rallied sharply over the last month and a half as investors have embraced the idea of a second-half recovery, but in the months to come higher interest rates could prove powerful headwinds to further market gains.

Since January, the Fed has dropped the fed funds target rate five times, bringing it down to 4% from 6.5%. On an absolute basis, that's the most aggressive cutting action we've seen since the early '80s. Yet during that time, the yield on the benchmark 10-year Treasury has risen by 0.32 percentage point, to 5.43% -- an indication that the bond market expects higher interest rates down the road. The December eurodollar contract is pricing in higher rates by the end of the year, while the March 2002 contract shows an expectation that the Fed will have tightened by at least a half-point by next spring.

Absolut Easing

To some, the market's expectation of higher rates next year makes sense.

"We're poised for a fairly strong rebound," contends

Bank One

deputy chief economist Diane Swonk. "I think we'll be stunned by the resilience of the economy by the end of this year. We'll be nipping at 4%

GDP growth once again."

With that higher rate of growth, says Swonk, will come the re-emergence of potential inflationary pressures, forcing the Fed to clamp down on rates once again.

Yet others think that in trying to anticipate the next rate hike, the market has entered into a mug's game.

Muggles

"It's kind of like trying to look past two corners," says

Aubrey G. Lanston

chief economist David Jones. After all, he points out, the economy hasn't rebounded yet, despite all the talk.

"I would agree that we will get a recovery, beginning perhaps in the fourth quarter of this year," Jones continues. "And at some point next year the Fed may have to switch to tightening." But Jones thinks that the recovery will be weak to begin with, because capital spending will remain soft and consumers, scared by the falloff in the stock market and the economy's cooling, will be rebuilding their balance sheets.

One could argue, however, that in trying to anticipate the next rate hike the market is merely recalling recent history. Less than eight months elapsed between the last rate cut in 1998 and the first hike in 1999. There were less than eight months between the last hike in 2000 and the first cut this year. In recent years, the Fed has shown a willingness to act very aggressively on interest rates, to risk going too far, and then compensate by reversing policy very quickly. And the Fed has been pretty much saying as much during the current round of cuts -- that it does not believe the economy is in recession, and that it is willing to overshoot to ensure that a recession will not occur.

The last time the Fed started raising rates, investors acted as if stocks were immune, bidding shares -- particularly tech shares -- higher even as the Fed tightened screws. That, as was subsequently shown, was a grave error. Whenever the Fed clamps down on rates again, whether it is early next year or at some later date, one imagines the market won't be so sanguine about it.