Is the


nearing the end of its rate-tightening campaign? That was certainly the belief Wednesday on Wall Street, leading both stocks and bonds to impressive rallies.


Dow Jones Industrial Average

finished up 81.58 points, or 0.8%, at 10,549.06. The blue-chip average earlier rose by more than 115 points, but came down as oil prices staged a rally of their own. July crude oil finished above $54, as bears were squeezed by a rally in heating oil.

Meanwhile, the

S&P 500

added 10.72 points, or 0.9%, to 1202.22, off a high of 1205. The


gained 19.64 points, or 1%, to 2087.86, off a high of 2095.

Behind the moves were unusually blunt comments from Dallas Fed President Richard Fisher, a voting member of the rate-setting Federal Open Market Committee. Using baseball terminology, Fisher said that the next FOMC meeting in June would be "the ninth inning" of the current tightening campaign.

As if to emphasize the point, just as the words were leaving Fisher's lips, the manufacturing index of the Institute for Supply Management came in soft. The headline index showed the manufacturing sector continued to expand, even if just barely, while the ISM's prices paid index fell to a 20-month low, as oil prices fell from April highs.

The market reached a happy conclusion: The "best of both worlds came in for the financial markets today," said John Sylvia, Wachovia's chief economist. "This opens the door to the Fed to pause in its pace of measured Fed funds rate increases."

According to Miller Tabak, a rate hike at the June 29-30 meeting is still a foregone conclusion, while odds that the Fed will move in August have fallen from 89% to 70%. Moreover, the market is now pricing in a near-zero chance that the Fed will hike interest rates at its September meeting.

Not surprisingly, bonds soared on the ISM data after having rallied Tuesday in the wake of an equally weak report on the Chicago region. The benchmark 10-year Treasury bond rose 25/32 in price to yield 3.89%, a 14-month low.

But why have stocks rallied? Clearly, the end of the rate cycle would be a relief for investors. Still, central bankers change lanes for a reason. Presumably a halt in interest rate-tightening would signal a belief among Fed officials that growth is at risk.

Interestingly, the anemic data on manufacturing has coincided with a ratcheting-down in analyst earnings estimates for the rest of the year. So far, that's most noticeably so for the second quarter, according to First Call estimates.

Overall, second-quarter earnings for

S&P 500

companies are now expected to be up 6.9% from last year's quarter. That's down from expectations of 8% year-on-year growth at the beginning of the quarter.

Not surprisingly, the decline is being led by the consumer discretionary sector, which includes the auto industry and the likes of

General Motors

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. On Wednesday, the Big Three automakers again posted disappointing monthly results. The sector's earnings are now expected to be down 3% from last year, compared with expectations of a 6% gain at the beginning of the quarter.

Also not surprising has been the downward revision in energy sector earnings, which reflects the declining price of crude. Still, at 23%, the sector is still the repository of the most optimistic second-quarter earnings growth estimates in the S&P 500.

Less obvious, however, is that growth expectations for the tech sector also have been cut to 13% from 9% at the beginning of the second quarter (so much for the rally's leading sector). For the third and fourth quarter, earnings estimates of 15.3% and 12.2% were also recently revised slightly downward, according to First Call. More revisions may come.

"Once again, that's being driven by the consumer discretionary sector, as analysts extrapolated that what happened in the second quarter may also take place in the remaining quarters of the year," says First Call research analyst John Butters.

The revisions aren't much to write home about. The manufacturing sector of the economy has been hit hard and that's being reflected mostly in consumer discretionaries, as expected.

But if the manufacturing sector does fall into a recession, as maybe the bond market is suggesting, then how long will it be until employment, consumer sentiment and retail get hit?

And economists also believe that the Fed, this time, would continue raising rates even if the ISM index were to fall below 50. Fed Chairman Alan Greenspan would wait to see a widespread impact on employment and retail sales before thinking of halting rate hikes, according to Lehman Brothers chief economist Joseph Abate.

The fed funds rate has to return to a "neutral" level, probably around 4%, simply because interest rates have been kept at historic lows over the past few years, economists say. That has fueled a number of easy-money excesses, not the least of which is the real estate bubble. In the middle of the rally Wednesday, the Philadelphia housing sector index continued to gain, adding 1.27%, as homebuilder

Toll Brothers

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rose 2.71%.

The inflationary impact of these excesses, and an expected increase in labor costs (which so far remain tame), may mean that the Fed will sacrifice the manufacturing sector for housing-led growth.

Goldilocks may have washed off her oil-tainted perm after the end of the first quarter. Nowadays she's living in Florida.

To view Gregg Greenberg's video take on today's market, click here


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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