Sliding on Shifting Sands

Stocks lose their early juice as the Philadelphia Fed disappoints.
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Stocks and bonds lost ground Thursday after the Philadelphia

Federal Reserve

Bank said its index of regional economic activity plunged in August and prices soared. The report was one of the first to reflect the early impact of Hurricane Katrina, particularly on energy prices.

The Philly Fed update offset previous optimism that the Northeast had weathered the storm intact and that consumer prices, outside of energy, remained tame before Katrina.

After trading moderately higher for most of the morning, the

Dow Jones Industrial Average

was down 12.66 points, or 0.12%, at 10,532.24. The

S&P 500

was down 1.30 points, or 0.11%, to 1225.86. The

Nasdaq Composite

was down 4.72 points, or 0.22%, at 2144.61.

Selling pressure also built as two airlines succumbed to the post-Katrina fuel crunch. Both

Delta

(DAL) - Get Report

and

Northwest Airlines

(NWAC)

confirmed they were filing for bankruptcy.

Bonds, meanwhile, fell on concerns that the surge in the prices paid by manufacturers will fuel inflation. The benchmark 10-year Treasury bond was recently down 15/32 in price while its yield rose to 4.22%.

The Philadelphia Fed said its regional business index plunged to 2.2 from 17.5, sharply below the consensus estimate of 13. New orders fell into negative territory for the first time in more than two years, with most of the businesses surveyed by the bank blaming high energy prices.

And bulls, who've been hopeful that Katrina's toll on the economy would push the central bank to pause its year-long rate tightening campaign, perhaps as soon as next week's meeting, could not find solace.

The Philly Fed said its prices-paid index jumped from 25.9 to 52.7, its highest level in seven months. Prices received rose only slightly, suggesting businesses were still not passing on higher costs to consumers. But that trend probably won't last, especially as businesses surveyed expect significantly higher prices over the next six months.

Earlier, the New York Fed said its Empire State manufacturing index dropped to 17 from 23 in August, above economist expectations for 15. But the index's prices components also surged.

As next week's Fed meeting approaches, there is still uncertainty over what the central bank will do. It's the first time a legitimate debate has surrounded an FOMC meeting since the current tightening campaign began 14 months ago.

The Fed and economists are still trying to determine how long the Katrina impact will last. They also wonder about the storm's net effect: Will it mainly be a tax on growth, or a driver of inflation?

But barring evidence of a looming economic recession, economists believe the Fed will stick to its inflation-fighting mission and keep raising rates until clearer readings of Katrina's impact emerge.

Economic reports released Thursday and earlier this week still provide an incomplete picture, since most of the data's collection preceded Katrina.

Claims for unemployment benefits in the week ending Sept. 10 provided the first full official glimpse at the Hurricane's impact.

According to the Labor Department, there were 71,000 more jobless claims in that week than in the previous one, bringing the total number of claims to 398,000. Wall Street economists on average expected 350,000 claims.

But the government admitted to being unable to process the unusually large volume of claims in Louisiana and surrounding states, which means that several hundred thousand more claims could be filed over the coming weeks.

The August consumer price index, meanwhile, reflected some of the impact from Katrina as well as the pre-Katrina surge in energy prices in August. The market was first heartened on news that the CPI rose 0.5%, in line with expectations, while the index's core, ex-energy prices, only rose 0.1%, less than the 0.2% expected.

But according to Mark Vitner, senior economist at Wachovia, core consumer inflation was held down by lower auto prices in August as automakers provided special sales incentives. There were also temporary drops in health-care costs and residential rent prices. All these trends are expected to reverse over the coming months. Auto sales have already dropped as incentives were unwound. In addition, food prices are expected to rise as high energy prices and transportation costs are passed on.

Mostly, rent and owners-equivalent rent, which estimates the rental equivalent of homeowners' costs, are expected to surge in coming months, Vitner says. Those two make up a third of the core CPI.

"Hurricane Katrina displaced around a quarter of a million people who are now buying homes, renting homes and leasing apartments," Vitner says.

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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