A slew of key economic data provided limited relief Friday to equity investors still reeling from the recent heavy selling pressure. But the data deluge will likely give more fuel to inflation concerns and ensure the Federal Reserve will continue raising interest rates for the foreseeable future.

Notably, core consumer price inflation was less than expected in September but headline inflation increased at the fastest pace since 1980. In addition, retail sales and industrial production data showed the economy remained on strong footing in September, excluding the hurricane shocks to the Gulf Coast.

Meanwhile, consumer confidence, as measured by the University of Michigan, failed to rebound in October, after plunging in September in the wake of the energy spike caused by hurricanes Katrina and Rita.

After rallying at the open, major stock indices fell back after the consumer confidence numbers. But shares rose again midday, partly helped by a drop in the price of crude oil, recently down $1.13 to $61.95 per barrel. Crude fell in part because of concerns over the fate of beleaguered commodities brokerage Refco ( RFX).

The Dow Jones Industrial Average was recently up 0.2% at 10,229.78, vs. its intraday high of 10,272. The blue-chip average was lifted, among others, by General Electric ( GE), which posted solid earnings before the market opened. General Motors ( GM) also gained after reports that it may unilaterally cut employee benefits.

The S&P 500 index was recently up 0.2% at 1179.40 after trading as high as 1185 earlier. The Nasdaq Composite was up 0.2% at 2051.31, after trading up to 2060. Among the gainers, Electronic Arts ( ERTS) rose 3.9% after saying it enlisted renowned film director Steven Spielberg to collaborate on video games.

Bond prices, meanwhile, continued to reflect rising inflation expectations. After rising in early trade, the benchmark 10-year Treasury bond was recently down 5/32 while its yield, which moves inversely to its price, rose to 4.49%.

Amid the inflation scare of the past few weeks, consumer prices ex-energy absorbed less of the recent spike in energy prices than economists and the market feared. Excluding food and energy, the Consumer Price Index rose 0.1%, below expectations for a 0.2% rise.

Headline inflation was worse than expected, however, with the CPI rising 1.2% in September, above expectations for the index to gain 0.9%.

In the month that followed the Katrina-induced spike in energy prices, economic indicators such as the Institute of Supply Management's surveys, as well as price increases implemented by companies, fueled concerns that inflation pressures would finally seep to core prices.

That hasn't happened yet but the core CPI will not continue "to defy gravity" for very long, according to Mark Vitner, senior economist at Wachovia. "In the past, a breakout in the overall CPI such as we have seen recently has eventually pulled the core CPI higher."

Headline inflation is now up 4.7% on a year-over-year basis while the core CPI is only up 2%. But "anecdotal evidence and common sense suggests that core inflation has not been anywhere near this tame," Vitner wrote. In September, overall energy costs surged 12%, after rising 5% in August and 3.8% in July. Energy costs are now up 34.8% year over year.

Meanwhile, these energy costs continued to weigh on consumer sentiment in October. The University of Michigan's index slipped 1.5 points to 75.4, against expectations for the index to rise to 80. This follows a plunge the previous month.

With underlying economic growth still rising at a decent clip, inflationary pressures continue to outweigh concerns about growth and ensure that the Fed will lift rates well into next year, says Michael Gregory, fixed-income strategist at BMO Nesbitt Burns.

Underlying industrial production remained strong in September. While headline production fell 1.3% in the month, more than expectations for a drop of 0.45%, this was mostly due to a 6.8% plunge in energy output from hurricane-related disruptions and the impact of a strike at Boeing ( BA).

According to Miller Tabak, the market is now pricing in a 100% chance of another quarter-point rate hike at the next Fed meeting Nov. 1, which would lift the fed funds rate to 4%. The odds of another hike on Dec. 13 are 96% while those of a January hike currently stand at 50%.

"The market is now correctly interpreting all the signals that we're going to get more rate tightening until at least the end of Fed Chairman Alan Greenspan's term early next year," Gregory says. "That's quite a departure from market expectations just a month ago."

There might be some hesitation at the Fed in December or in January, when soaring heating costs take another bite out of consumers wallets. Lifting rates much further would also continue to squeeze indebted consumers, Gregory says. "Greenspan may want to take just one final pause to leave room for his successor to deliver the last few rate hikes and ensure a seamless transition."

Regardless, rising inflation expectations will likely lead the yield of the 10-year bond to 4.70% over the next few months, with risks that it may reach 5.0% after, the BMO strategist says.

While that's still a long way ahead, the stock market could have trouble finding traction as the yields of risk-free fixed-income assets become more and more attractive.

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; click here to send him an email.

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