Once again, it was the last half-hour of trading that provided most of the stock market's strength.

The latest inflation report was anticlimactic at best, and the data on core consumer prices for May didn't provide the dramatic inflection point that many had hoped for.

The Labor Department reported that overall consumer prices gained 0.4% in May, less than the 0.6% climb in April, while core prices, excluding food and energy, rose 0.3% for the third consecutive month, solidly baking in a fed funds rate increase at the end of June.

Expectations were for a 0.4% advance in the headline CPI and a 0.2% rise in the core. Now there's no more inflationary data standing between the

Federal Reserve

and its rate hike, but there is plenty of time to get worried about overshooting. The fed funds futures market has put the odds of a hike to 5.25% later this month at 100%.

Even a nice tidbit of certainty didn't quell the markets. The Fed's beige book came out stating that the economy was still growing last month, but, predictably, also pointed out signs of slowing consumer spending and a cooling housing market. Several economists have recently begun contemplating fed funds rates as high as 6% before the Fed's tightening is over.

"

Ben Bernanke will bite the bullet and hike the funds rate on June 29 by 25 basis points and word the announcement in such a way to indicate that the

Federal Open Market Committee is leaning toward yet another rate increase on Aug. 8," Paul Kasriel, an economist at Northern Trust, wrote in a research report.

"This will help establish Bernanke's credentials as a hard money man with the influential editorial page writers of

The Wall Street Journal

," he continued. "This will give Bernanke the flexibility to pause at the Aug. 8 FOMC meeting when it will be apparent to all that real economic growth is in trouble."

Meanwhile, the major stock market averages finished the day in the black. The

Dow Jones Industrial Average

rose 1.03% to 10,816.92, and the

S&P 500

gained 0.52% to 1230.04. The

Nasdaq

skirted a ninth down day by rallying 0.65% to 2086. The Dow transports average, which was the only index to reach an all-time high this May, ended the day up 0.67% at 4470.94.

The Dow's biggest boosts came from

Intel

(INTC) - Get Report

and

Boeing

(BA) - Get Report

, both of which benefited from positive research.

Bank stocks remained on the downside as inflation fears and rising rates threaten to compress their profit margins.

Bank of America

(BAC) - Get Report

lost 1.4%,

Citigroup

(C) - Get Report

fell 1.2% and

JPMorgan Chase

(JPM) - Get Report

dropped 2.2% on the day.

The Blame Game

Most good traders say that they lose their edge when they start pointing fingers to explain their bad bets. The blame game for the market's downturn since mid-May has gotten out of control. Investors appear caught off guard almost every day when the market unpredictably shifts or intensifies in the last half-hour of trading.

On Wednesday, that shift happened to be to the upside, but more frequently it has been a decline. Bernanke has borne most of the blame for the market's volatility, but the real responsibility might rest with hedge funds.

Hedge funds have been using complicated derivatives transactions to capture returns based on the low volatility and low-risk environment that easy money provided over the past three years. Once liquidity started to drain out of the market a couple of months ago when the Bank of Japan stopped its quantitative easing, a steady stream of monetary-policy tightening took shape around the globe. Hedge funds have been forced to unwind many trades where they're losing money and sell securities to settle derivatives contracts.

One derivative in particular has pressured late-day trading recently, hedge fund managers say. Many traders have bet on volatility with an instrument called a variance swap. The writers of those contracts have to pay up, or not, depending on closing stock market prices. The contracts have been responsible for much of the volatility on down days, according to one hedge fund manager who didn't want to be named.

"This shows that hedge funds have grown to a size where they impact the market, absolutely, no question about it," says Mary Ann Bartels, a technical research analyst at Merrill Lynch. Several sources say that hedge funds are seeing redemptions, liquidations and reversals of 20% to 30% of the gains made in the first four months of this year. No one would name names, however.

Bear Market?

The main issue becomes a question of when it spreads, says Bartels, noting that the traditional investing community hasn't yet run for the hills. Equity mutual funds have still seen net inflows since the beginning of May, she says.

That said, the online brokerage industry may be starting to see

waning enthusiasm from retail investors.

E*Trade's

(ET) - Get Report

clients made fewer trades in May, and its customer assets declined 5%.

To be sure, some professional investors have used the term bear market for the current situation, which may mean the tide is about to turn.

"I wouldn't want to go long in the stock market right now," says Matthew Smith, vice president and portfolio manager at Smith Affiliated Capital, which has $1.4 billion in assets under management. Smith says the upcoming midterm elections, a slowing economy and rising rates threaten the outlook for stocks.

Long-duration government bonds are about the only safe place he can see. The long end of the yield curve is in high demand and short supply. U.S. bonds still provide the highest yields relative to the rest of the world, barring Australia. He owns those government bonds, too.

The yield curve remained inverted as bonds sold off a bit in preparation for the Fed's rate hike. The 10-year Treasury note yielded 5.06% late Wednesday, and the two-year was yielding 5.12%.

While the markets clearly saw some relief this day, the hedge fund and derivatives in play are a new force to be reckoned with. The CPI might have been a disappointment, but surely there's a real climactic event looming out there somewhere.

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

here

to send her an email.