This morning, in the wake of a truly hideous report on the Midwestern manufacturing economy, the stock market took a sharp jog lower. And then, against all good sense, jumped higher.

The Chicago Purchasing Managers index, or PMI, dropped to 38 in July from 44.4 in June, a far greater pullback than economists had expected. The report put the kibosh on recent optimism that the region's manufacturing base, dominated by the auto industry, had begun to find its footing. Yet in the equity arena, traders chose not to dwell on the bad news, focusing instead on a belief that the report opens the door to a half-point cut at Federal Open Market Committee's meeting three weeks from today.

That belief is unfounded.

In testimony before Congress two weeks ago,

Fed

Chairman Alan Greenspan signaled that, absent some disaster, the Committee won't be taking down rates at the half-point clip seen earlier this year.

"Certainly, should conditions warrant, we may need to ease further," quoth the Chairman. "But we must not lose sight of the prerequisite of longer-run price stability for realizing the economy's full growth potential over time." Following the speech, a

Reuters

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poll showed that economists at all 25 primary dealers expected the Fed to cut rates by a quarter-point at its August meeting. Speeches from other talking Feds at the bank have only served to strengthen the impression that it will not cut aggressively.

"They basically told us they would expect further easing to depend on the data and be in quarter-point steps," says Salomon Smith Barney economist Steven Wieting. "They've already made their decision."

Stop Making Sense

One really bad report isn't going to change that. Not even a couple really bad reports would. To begin with, the Fed has made no bones about how dismal things are for the manufacturing economy. Bad data are to be expected. For another, cutting by 50 basis points after all it has said wouldn't engender confidence in either the Fed or the economy. "To come back with a 50-basis-point cut in August," says Morgan Stanley economist Bill Sullivan, "would suggest a sense of panic."

Take away the chance of a half-point cut out of the Chicago index, and all you're left with is a horrible report showing that the pain in manufacturing is far from over and that recovery is months away.

"What looked like some stability in the factory segment of the economy has gone by the wayside," says Sullivan. "It appears you have a new tranche of weakness in the economy."

Hardly the sort of thing that one thinks of as the starting point for a sustainable rally in stocks. Indeed, today's big move higher in the indices seems like little more than a pipe dream, based on the misperception that the Fed will be more aggressive than it will be, coupled with denial over what the Chicago report truly augurs for U.S. companies.

That said, the move higher is broad-based, spanning across the market. And then there's that truism about how, when stocks start sloughing off bad news, good things are likely to come.

"You have to give it the benefit of the doubt," says W.R. Hambrecht head of listed trading Todd Clark of the rally off the Chicago report. "Even though it is a perverse reaction."