What a Week: Passing Ships

Bernanke and China's central bank go separate ways, roiling the dollar and commodities. But stocks hold up relatively well.
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The

Federal Reserve

and China's central bank took opposing tacks on monetary policy this week. Fed chairman Ben Bernanke indicated a pause in tightening, while China raised a key interest rate.

The ensuing crosscurrents sank the U.S. dollar, drove up Treasury yields, and left major stock proxies in limbo. Commodities weren't sure which way to go until Friday, when the International Atomic Energy Agency sent them solidly upward by stating that Iran defied U.N. rules by continuing to enrich uranium.

Gold reached another 25-year high Friday as the metal for June delivery jumped 2.9%, to $654.50 an ounce, after touching a new 25-year intraday high at $655.50. That is up from $635.50 last Friday. The new silver exchange-traded fund,

iShares Silver Trust

(SLV) - Get Report

, ended its first day of trading up 7.07%, or $9.12, at $138.12. After topping $75 per barrel last Friday, the price of light, sweet crude oil fought back Friday to close at $71.57.

Meanwhile, the stock market didn't move as much as it could have -- and was certainly tame relative to other markets -- while the dollar and Treasuries took a more solidly bearish stance on inflation.

The

Dow Jones Industrial Average

was down 15 points to 11,367.14 Friday, but up 0.2% for the week, its fourth-straight weekly advance. The

Nasdaq Composite

finished down nearly 1%, at 2323 Friday, and was down 0.9% on the week. The

S&P 500

was essentially flat on the week, down a hair to 1311.

For the month of April, the Dow rose 2.3% and the S&P gained 1.2%, but the Nasdaq fell 0.7%.

The dollar was the battlefield for the global-imbalance wars this week, which began with a directive from the Group of Seven nations calling for stronger Asian currencies. Regardless of the G7's intent, currency traders interpreted the

communique

as calling for a weak dollar.

Meanwhile, Bernanke, in his testimony to the Joint Economic Committee on Thursday, essentially asked China to revalue its yuan as a step toward relieving the U.S. trade deficit. But the Central Bank of China already had surprised markets earlier that day by tightening its economy -- not with a forex tweak, but by increasing its one-year borrowing rate 27 basis points to 5.85% from 5.58%.

"This was an important week," said Dennis Gartman, editor and publisher of the Gartman Letter. "This is the first of many more rate increases to come in China."

While the dollar fell against the yen on the G7 news, its deepest plunge this week was against the Canadian dollar, due to the strength of commodities, many of which are made in Canada. The U.S. dollar was at 1.1174 against the Canadian dollar late Friday -- a price not seen since 1978, said one currency trader. The euro was trading at $1.2624, its highest level since May 2005. The dollar was trading at 113.82 to the Japanese yen vs. 116.65 last Friday.

The dollar felt the pinch all week of reports from foreign central banks that the U.S. currency is playing a smaller role in their reserves, said one currency trader. All the while, U.S. Treasury Secretary John Snow stubbornly insists the country still has a "strong dollar" policy.

The G7 statement and China's rate hike hit Asian stock markets as well. The combination caused the Nikkei to sell off on fears that a stronger Japanese currency will hurt its exporting abilities. The Nikkei dropped 2.8% Monday, and fell 1.22% Friday.

The dollar's weakness, which may increase other countries' attraction to U.S. products, also may mean inflation -- the X factor for the markets this week. Ahead of Bernanke's testimony to the Joint Economic Committee Thursday, the U.S. Treasury bond market sold off sharply on strong U.S. housing data and durable-goods orders. The hoopla

last week over the 10-year yield breaking 5% quickly faded as such yields became the norm. The 10-year ended the week at 5.06%, while the two-year finished at 4.98%. The Treasury selloff dampened somewhat after

Zen Ben indicated a pause in hiking the fed funds rate, but signs persist that inflation is near.

For example, the yield spread between 10-year TIPS and 10-year Treasuries is climbing, which shows expectations that inflation is growing, according to Miller Tabak.

Elsewhere, the Commerce Department reported a strong 4.8% first-quarter GDP Friday, which was in line with expectations. But data on new and existing home sales, durable-goods orders and consumer confidence all surprised investors on the upside this week. The data dashed the "one and done" crowd's hopes that a pause in Fed tightening really meant a reversal in monetary policy. Bernanke cleared that up in his testimony, stating clearly that the pause in June may not be an end to tightening, but just a way to collect data and monitor the lag effect of the past 15 rate hikes.

Notably, stocks didn't rally dramatically on Thursday, even though the prior week's dovish stance was confirmed by Bernanke.

"Investors have been hesitant to make a really big deal out of this pause," said Charles Blood, director of strategy research at Brown Brothers Harriman. "If they were really convinced it would have been a breakout week."

Odds that the Fed will hike the fed funds rate at its June meeting ended at 24% Friday, down from 64% on Wednesday and 46% last Friday, according to Miller Tabak.

If such clear words from Bernanke can't drive a bigger stock rally, perhaps it is a sign that there is a storm brewing behind all the economic growth. It has been a long time since the market has seen a relevant correction. "The stock market is still trying to sort out whether a pause would be a good thing or not," said Blood.

Clearly,

Microsoft's

(MSFT) - Get Report

earnings were partly to blame for Friday's lackluster stock market. The company's shares dropped 11.38%, or $3.10, to end at $24.15 per share, and trading volume in the stock accounted for almost one quarter of the Nasdaq's entire trading volume. The company missed earnings expectations and gave lower guidance. At the same time, its executives said the company would increase its spending by $2 billion in fiscal 2007.

Exxon Mobil

(XOM) - Get Report

,

Chicago Mercantile Exchange

(CME) - Get Report

and

Coach

(COH)

also reported disappointing earnings and/or guidance this week.

Still, about 70% of companies overall beat estimates, according to Thomson Financial. But, signs of inflation were littered throughout the releases. Companies such as

Caterpillar

(CAT) - Get Report

,

Alcoa

(AA) - Get Report

and others said they've been able to pass through to consumers the high cost of raw materials.

With the end of earnings season looming and Americans feeling the pain of high energy prices, Bernanke's first-quarter growth "spurt" is almost behind us. President Bush felt compelled to tout 4.8% GDP on the White House lawn Friday, adding, "We have to keep our feet on the pedal of this economy."

But if inflation tips the scales too far, this past week of relative quietude in the stock market might prove to be the calm before the proverbial storm.

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

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