Cautious comments by the Federal Reserve, the dollar's weakness, and lackluster same-store sales took some air out of the stock market's rally this week. But in the end, the market's latest trial balloon of bullishness stayed afloat.

Thanks largely to Friday's gains, major averages secured modest weekly gains, with the Dow Jones Industrial Average up 0.3%, the S&P 500 higher by 0.4% and the Nasdaq Composite up 1.2%.

The final tallies notwithstanding, this week saw major averages face the first real obstacles to the rally that began in mid-March. Most prominently, the Federal Open Market Committee said Tuesday that the economy's risks are weighted toward weakness and warned about an "unwelcome substantial fall in inflation." Minutes of the FOMC's March 18 meeting, released Thursday, showed more overt concerns at the central bank about "disinflation in core prices."

Those comments were quickly interpreted by Wall Street as a reason to resume worrying about deflationary pressures, which weighed on shares midweek.

"The Fed is playing the expectations game," said Gerald Cohen, senior economist at Merrill Lynch. "They changed the risk-assessment statement but are not saying 'it's a growth issue' but that 'we're as vigilant about deflation as inflation.'"

Renewed concerns about deflation dominated financial markets this week (more below). Coincidentally, or not, those fundamental challenges arose just as stock proxies reached the upper end of trading ranges bracketed by the December highs and October lows.

The S&P 500 traded as high as 939.49 and closed at 934.39 Tuesday vs. its Dec. 2 intraday high of 954.32 and closing best of 934.53. The Dow surpassed its March high of 8522 on Monday, triggering a buy signal for devotees of Dow Theory, and closed above 8600 Friday for the first time since mid-January.

From a technical point of view, it's logical that major averages would stall after reaching the upper end of trading ranges, especially after such a sharp rally. That they didn't fall further, and that declines tended to occur on lower volume, suggests the rising trend from the March lows remains intact, at least for now.

Also, the Nasdaq continued its trend -- intact since the October lows -- of being the first major average to eclipse significant technical hurdles, as noted here previously . This week, the Comp traded as high as 1532.82 Tuesday and closed at 1523.71, surpassing its Dec. 2 intraday best of 1521.44.

Whether the Dow and S&P can follow the Comp's example and move above their December highs remains to be seen. Also, skeptics contend that leadership from a prior bull market cannot be at the vanguard of the next bull move, or at least that it's unprecedented.

The Comp was the relatively weakest performer Wednesday, amid consternation about Cisco's ( CSCO) tepid outlook . But the index was back in the pole position Friday, rising 2% to 1520.15, thanks to some optimistic comments by Intel ( INTC) and better-than-expected results from Nvidia ( NVDA).

The Dow rose 1.3% Friday to 8604.60, while the S&P 500 gained 1.4% to 933.41.

Volume was tepid Friday, and the gains seemingly amounted to a reprieve from the fundamental concerns that dominated the week. (The Senate's revival of dividend tax reform, even a watered-down version, may have aided shares, as many traders had effectively written off such prospects.)

The D-Word, Bonds and the Buck

Another purported factor in Friday's rally were comments by Treasury Secretary John Snow, who, in response to the aforementioned concerns expressed by the Fed, told reporters: "I don't think the U.S. has any risk of being in a serious deflationary period" and "any comparison to Japan would be inappropriate."

Snow's comments may have aided shares but did little to help the beleaguered greenback, which suffered another series of four-year lows this week vs. the euro, which traded above $1.115 Thursday and intraday Friday, before retreating to around $1.1488.

The euro was boosted by a combination of factors, including the European Central Bank's decision to leave rates unchanged and ongoing concerns about the pace of U.S. economic growth. (In a relatively light week for economic data, traders focused on disappointing same-store sales data from retailers such as Wal-Mart ( WMT).)

The ECB said it is targeting inflation rates "close to 2%" over the medium term vs. "below 2%" in the past.

That subtle shift "gives the ECB added flexibility in tackling downside price risks by securing the ability to ease monetary policy even with inflation at 2.0%," observed Ashraf Laidi, chief currency analyst at MG Financial Group. Still, traders seemed to focus mainly on prospects for a Fed rate cut this summer, not one from the ECB.

Earlier in the week, Snow had said: "It has been the U.S. administration's policy for many years to support a strong dollar. But it's also policy to recognize the dollar's value is best set in an open, competitive currency market with a minimum of interventions."

Currency traders took that comment as Snow's way of discouraging the Bank of Japan, most notably, from intervening in currency trading to support the dollar. Fittingly, the dollar fell 1.5% vs. the yen this week, trading at 117.25 yen late Friday after hitting a 10-month low of 116.06 yen on Wednesday. For the week, the Dollar Index fell 1.85% to 94.97.

The dollar's weakness served as a somewhat perplexing backdrop to the rampaging strength in Treasuries, which occurred despite the government's record $58 billion refunding auction of three-, five- and 10-year notes. For the week, the yield on the benchmark 10-year note fell 23 basis points, ending Friday at 3.69%.

This column examined some possible noneconomic factors contributing to the near multidecade-low 10-year Treasury yields, including speculation the Fed is buying long-dated maturities to combat deflationary pressures. Such explanations should allay concerns that the bond market is suggesting the stock market is "wrong" about pricing in an economic recovery. Still, Treasury yields would be higher if fixed-income participants saw the kind of robust growth some equity participants are anticipating. ( contributor Howard Simons offered to examine whether stocks or bonds have historically been more prescient in forecasting economic trends; I'll report on the results.)

Tune-In TaskMaster

I'll be on WABC radio's Batchelor & Alexander show Friday evening, around 12:35 a.m. EDT. (OK, that's really Saturday morning for East Coasters). The show is nationally syndicated, so check for local listings or Webcast options.
Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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