Fed Surveys Katrina's Impact

Major averages overcome a weak ISM report as pressure builds on Greenspan to stop tightening.
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Investors, still trying to figure out the extent of the fallout from Hurricane Katrina on the economy and profits going forward, are now on

Fed

watch. Major averages recovered from early losses Thursday amid rising expectations that the Federal Reserve will halt its yearlong campaign of rate hikes.

News that manufacturing activity slowed in August and that consumers' savings were negative in July had put pressure on major stock proxies in morning trade. But the trend reversed as oil prices dipped and after a report that Fed Chairman Alan Greenspan would meet President Bush, presumably to discuss Katrina's impact on the economy.

The

Dow Jones Industrial Average

was recently up 4.94 points, or 0.05%, at 10,486.54, after falling as low as 10,425 in early morning trade. The

S&P 500

was up 3.52 points, or 0.3%, at 1223.85, off a low of 1216. The

Nasdaq Composite

was flat at 2152.09, off a low of 2142.

As Katrina's deep impact on the economy is becoming clearer, investors are increasingly discounting the possibility that the Fed will lift its foot off the monetary brake, after raising short-term interest rates by a quarter-point 10 times in the past 13 months.

Dave Rosenberg, chief economist at Merrill Lynch, noted that Greenspan had cut rates in 1996 after a large snowstorm had shut down the Northeast. Back then, the core inflation rate was 3%, instead of 2% currently. "Now, Katrina's effects are felt nationally," and they "appear a whole lot bigger and far-reaching than that or any other natural disaster in recent times," he says.

According to Miller Tabak, the odds that the Fed will again hike rates at its Sept. 20 meeting have now fallen to 56% from 90% on Wednesday and those of a Nov. 1 hike have dipped to 20% from 100% on Monday. The market is now expecting that the Fed will stop raising rates after one more rate hike this year, and expects one more hike next year.

In recent action, the benchmark 10-year Treasury bond was down 7/32 and its yield rose to 4.04%. The yield previously dipped below 4% but hit resistance at 3.99%. The two-year note, however, which reacts the most to Fed rate hikes, was gaining ground, adding 3/32 and its yield falling to 4.33%.

Economic data released Thursday did little to contradict the market's lowered expectations of future rate hikes.

The Institute for Supply Management said its index of manufacturing activity fell to 53.6 in August from 56.6 in July, against expectations that the index would rise to 57.2. While readings above 50 still indicate expansion in manufacturing, the much weaker-than-expected number came in at a bad time as the market is already worried about the economy in the wake of Katrina's devastation.

Earlier news that spending rose 1.0% in July, as expected, was weighed against the fact that consumers spent money they didn't have, as personal income rose a paltry 0.3% in the month. The personal savings rate dipped to negative 0.6%, the lowest level in 46 years and only the second time this has ever happened, the last being right after the Sept. 11, 2001, terror attacks.

"We're spending all we have and more and that cannot last," says Joel Naroff, president of Naroff Economic Advisors. "Very simply, unless income growth accelerates, spending will have to slow and Katrina has created further uncertainties about the fall."

Since Katrina hit Monday morning, gasoline prices have soared as refinery outages are expected to go on for weeks in the Southwest.

Crude oil was down in recent action, losing 24 cents to $68.70 per barrel, after the government Wednesday opened the nation's strategic petroleum reserve to provide crude to refineries. But gasoline prices continued to gain, adding 17 cents to $2.43 per gallon on Nymex. Gasoline has soared more than 30% over the past four days.

Retail gasoline prices are now expected to top $3 per gallon next week and some economists are even saying that a gallon may reach $4 eventually.

That also put in a different light news that retailers fared better than expected in August. After

Wal-Mart

(WMT) - Get Report

warned last month that its customers were already feeling the pinch of soaring gasoline prices, expectations that others would soon follow had not yet materialized in August.

Target

(TGT) - Get Report

,

Costco

(COST) - Get Report

and

J.C. Penney

(JCP) - Get Report

posted strong same-store sales in August, and higher-end retailers such as

Nieman Marcus

(NMG.A)

and

Nordstrom

(JWN) - Get Report

did even better.

But as gasoline prices keep rising, consumption will be affected across higher and higher income levels, analysts believe.

In addition, many retailers have a large exposure in Gulf Coast states that have been hit by Katrina's devastation. According to Citigroup analyst Deborah Weinswig,

Dollar General

(DG) - Get Report

, with 18% of its business there; Neiman Marcus, with 16%; and

Federated

(FD)

, with 15%, have the highest exposure in the area. Other retailers with significant exposure include

Saks

(SKS)

,

BJs

(BJS)

, Wal-Mart and

Family Dollar

(FDO)

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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