What a Week: Volatility Rules

A short week holds a lot of drama, as emotions swing from fear of the Fed to worries about growth.
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Get back. Get back. Get back to where you once belonged.

The Beatles were talking to Jo Jo the loner from Tucson, Arizona, but the sentiment applies to Friday's markets. The Treasury market, in particular, capped off a data-heavy week telegraphing to the

Federal Reserve

that it shouldn't go too far to fight inflation if growth is slowing too sharply.

The Fed is in a "damned if you do, damned if you don't" scenario. It gained credibility this week by discussing inflation pressures more seriously, as revealed

Wednesday in the minutes of the May 10 FOMC meeting. But it started to seem too hawkish as Friday's lackluster payrolls report sank in.

One of the economy's meatiest data points, the U.S. Labor Department's nonfarm payrolls report, revealed Friday a sharp slowdown in the labor market, but no new inflationary pressures. Therefore, the Fed's dilemma gets murkier and the CPI report later this month looms larger. After the May FOMC meeting minutes appeared to seal the deal on a fed funds rate hike in June, the debate over the Fed's ability to pause after the labor report was resurrected. After a week filled with data, there is still fuel for all sides. One thing is sure,

volatility is now the norm.

"The data dependency of the Fed, plus the transparency of the Fed, boost the volatility," says Brian Wesbury, chief economist at First Trust Advisors. "We go from one day pricing in a rate hike to the next day pricing in no rate hike."

The fed funds futures market puts the likelihood of a fed hike in June back in the 50-50 world Friday, after rising to 75% after the FOMC minutes came out Wednesday.

The

Dow Jones Industrial Average

fell 0.1% Friday to 11247.87, weighed down by

IBM

(IBM) - Get Report

and

General Motors

(GM) - Get Report

, ending the week down less than 1 point. The

S&P 500

rose 0.2% to 1288.22, up 0.6% on the week. The

Nasdaq Composite

fell 0.2% Friday to close at 2219.41, but it was up 0.4% on the week.

Among stocks in the news,

NYSE Group

(NYX)

gained 3.3% on news of its definitive agreement to merge with the Euronext in a $10 billion deal.

But homebuilders

Pulte

(PHM) - Get Report

and

Hovnanian

(HOV) - Get Report

were down 5.2% and 2.7%, respectively, as their outlooks for future earnings slips away with the waning residential housing market. Pulte cut its earnings guidance and reported a 29% decline in new orders for April and May. Hovnanian was downgraded by JPMorgan.

After a rough start to the holiday-shortened week, metals companies fared well Friday.

Newmont Mining

(NEM) - Get Report

gained 3.15% and

Freeport McMoRan

(FCX) - Get Report

gained 1.94%.

As stocks struggled Friday, bond prices rose and yields fell sharply. Back into hiding went the bond market vigilantes after being out in force just a few weeks ago when the 10-year Treasury's yield reached 5.19%. On Friday, the 10-year's yield dipped below the 5% fed funds rate and finished the week yielding 5%, down from 5.10% Thursday and 5.05% at the end of last week.

The dollar fell Friday, following the likelihood of more Fed rate hikes. The dollar index sank 0.9% to $84.05, its worst close since May of last year. The price of oil gained to a three-week high of $72.05 per barrel following an attack on an oil rig in Nigeria and fears about Iran's nuclear program.

The Labor Department reported that 75,000 new jobs were added to nonfarm payrolls in May, less than half the expected 180,000, and the smallest gain since October 2005. This marks the third month of declining payroll reports. In April, nonfarm payrolls increased by 126,000, and March saw a 175,000 gain. The inflation component to the jobs report was benign, as average hourly earnings in May roles only 1 cent -- a 0.1% monthly increase, lower than the 0.2% expected increase. The markets welcomed this report after April's much higher-than-expected 0.6% increase. Year over year, hourly earnings were up 3.7% in May. Unemployment fell 0.1% to 4.6%, its lowest level since July 2001.

The rest of the week's data was mixed, though overall, it pointed to slowing growth. Manufacturing was down, while prices paid by manufacturers pointed to some inflation. Residential real estate is slowing, and auto sales were dismal, while same-store sales reported by most retailers were stronger than expected. Productivity for the first quarter was revised to more robust levels, while unit labor costs were revised down.

It was the FOMC minutes, however, that took center stage this week after the stock market

tanked Tuesday, forming the second bottom of a potential "W" formation that veteran technician John Bollinger says may lead to a new surge toward all-time highs, as reported

here.

Despite a more hawkish Fed, stocks took off after the minutes were released, finishing strong on Wednesday and rallying Thursday. Stock investors seemed happy to see the Fed acknowledge inflation pressures in the FOMC minutes. Indeed, Bernanke and the Fed appeared to shore up some much-needed credibility by throwing out the possibility of a 50-basis-point rate hike.

But, in an unexpected twist, stocks fell for most of Friday on the heels of the jobs report, even though the data makes a Fed pause more likely. The action reflected an

ongoing shift from concerns about inflation to concerns about growth. Or perhaps there are some stock market vigilantes at work, says Wesbury, who believes the Fed is behind the curve in fighting inflation. A Fed pauses now means having to go farther later, which would be much worse for stocks, he says.

"I don't think the Fed will be insensitive or blind to what the financial markets may tell it between now and June 29," says John Lonski, chief economist at Moody's Investors Service.

Now the markets just need to make up their minds.

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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