Back in the Saddle

From most reports it looked as if last week was as good as any to take vacation, as the drama on Wall Street was hard to find. Today, on the eve of the latest

most crucial

gathering of the

Federal Open Market Committee

, the action was downright soporific. Trading volume remained extremely light, but a final-hour flurry of buying helped the

Dow Jones Industrial Average

close up 0.5% and the

S&P 500

up 0.3%. The

Nasdaq Composite

finished off 1.2% at 2081.92, but bounced from its intraday low of 2052.41.

The recent quietude comes while investors debate whether the

Fed

will lower

rates by 50 basis points or a mere 25 when it meets tomorrow.

From the stunningly beautiful vantage point of the Mendocino Coast last week, I was tickled to read that the market's decline Friday (and for the week) was attributed to stronger-than-expected economic data. Casting doubt on the size of the next presumptive rate cut seemed a ready-made excuse for some good old-fashioned profit-taking after recent gains (and also for some good old-fashioned financial markets gibberish).

Of course the Fed will still lower rates by 50 basis points on Tuesday because it'll want to sustain the upturn in consumer confidence and corresponding strength in retail sales

, I thought. The Fed's strategy this year seems pretty clear: Keep the rate cuts coming fast and furious in the hopes of fueling consumer spending in order to keep the economy afloat until corporate America can correct both its inventory problems and its own flagging confidence.

I still believe the Fed will stick to that "strategy," and the

fed funds futures are still forecasting a 50-basis-point cut, albeit with less certainty than a week ago. Still, the view from the office is less clear than from the bluffs above

Irish Beach, and certainly there is dissention in the economists' ranks.

"In my mind it's a tossup whether they do 25 or 50" basis points, said Paul Kasriel, chief U.S economist at

Northern Trust

in Chicago.

Arguments for a 50 basis-point ease include the disappointment financial markets will likely register at anything less and political pressure on the Fed, Kasriel said. "I think

Alan Greenspan

could be sensitive to that and decide: 'Let's try to pump up the economy now and let my successor worry about inflation.' "

Arguments for a 25-basis-point cut include the aforementioned data from Friday, plus the surge in unit labor costs in last week's otherwise dour productivity report, the economist said. "There are some

FOMC members who should be concerned about inflation."

Kasriel has long warned about

inflation's return. While most economists and pundits pooh-pooh the threat, he notes "the market seems to be growing more concerned," judging by the steepening

yield curve, the

long bond's muted reaction to Fed rate cuts this year, and the widening spreads between Treasury bonds and their inflation-indexed counterparts (Treasury Inflation Protection bonds, or TIPs). "Economists can talk all they want, but people betting real money are beginning to bet in favor of higher inflation."

Kasriel again hammered on a theme that, in a nutshell, goes something like this: Energy constraints are hurting productivity and thus the supply of goods, while the Fed's "pressing on the monetary accelerator" is simultaneously reviving demand, resulting in inflationary pressures.

As a corollary, those who continue to believe inflation is a bugaboo should consider buying long-dated Treasury bonds, which have lately tanked. Or shorting precious metals stocks, which have been building strength in recent weeks, as technicians such as

John Roque and

Gary B. Smith have observed.

Views of a Differing Opinion

William Dudley, director of U.S. economic research at

Goldman Sachs

, stands (and sits, I guess) in stark contrast to Kasriel on the outlook for both tomorrow's FOMC meeting and inflation.

Dudley expressed a high degree of confidence the Fed will ease by 50 basis points. Also, despite forecasting a spike in the April

Consumer Price Index

on Wednesday, he believes "the inflation risk is not that great" because "the economy is going to be weaker than most people anticipate." Goldman forecasts

gross domestic product

growth of 1% in both the second and third quarters, and 2% in the fourth quarter. No recession, but anemic growth.

Dudley maintains 3.50% as his target for the fed funds rate this year, which seems much less radical today than when expressed here back in

late January.

Given that forecast, Dudley suggested the Fed will use its statement tomorrow to imply that it is getting close to the end of its easing cycle, perhaps by highlighting how much rate cutting has already occurred this year. "They won't rule out

additional cuts but will imply they hope they're done," he said.

Diane Swonk, deputy chief economist at

Bank One

also believes 50 basis points and no change in bias are in the cards for tomorrow. She called the accompanying statement the "only notable thing" about tomorrow's meeting, but believes those looking for hints as to whether the Fed is close to the end of its easing cycle will be frustrated.

"The Fed doesn't want to convey where it's at in that spectrum yet, and that uncertainty may leave the markets a little on edge, even though things come out

of the meeting as expected," Swonk said.

The markets on edge in the wake of the Fed meeting is also the expectation of Don Hays of

Hays Advisory Group

in Nashville, Tenn. Hays maintains

a belief stocks will remain strong into the latter half of the year, but believes "it's time for rebuilding the 'wall of worry' " in the near term.

That wall would quickly rise if the Fed were to cut rates by only 25 basis points tomorrow, Hays surmised, or if Greenspan were to "take a sabbatical from his recent rate cutting" because of the recent hints at economic recovery. Hays didn't outright predict no rate cut tomorrow, but raised the possibility.

Meanwhile, there's also an argument that a 50 basis-point cut could hurt stocks, at least temporarily, if investors fret the Fed remains panicked over the state of the economy. Once again, Greenspan finds himself in an ever-shrinking box of his own making.

Full Circle

For the record, Hays believes the market will stall later in the year or early in 2002 because the economy will prove weaker than most anticipate, resulting in a loss of faith in the Fed. While acknowledging recent increases in lumber and gold prices, he views any inflationary forces as fleeting.

During my Mendocino musing I couldn't escape a nagging feeling that if those predicting inflation and those forecasting persistent economic weakness both prove correct, we could be facing

stagflation revisited.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.