Hold tight, wait till the party's over. Hold tight, we're in for nasty weather. There has got to be a way: Burning down the house -- Talking Heads

These have got to be strange times when the stock market cheers news that new-home sales plunged 10.5% in February, which is what happened Friday. Even permabulls can't deny the slowing of the housing market, this major engine of the economy for the past few years.

Yet Wall Street's reaction to the news tells the story of the past two weeks. The name of the game has been to take economic data as either supporting or contradicting hopes that the Federal Reserve will soon stop raising interest rates.

The obsession reached a fever pitch ahead of the Fed's rate-setting meeting next week. Some in the market even hope the central bank will deliver the final rate hike of its 20-month long tightening campaign.

Adding to market jitters, the meeting will be the first to be presided by new Fed Chairman Ben Bernanke, who took over from Alan Greenspan in February.

In that context, evidence of weakness in housing was seen as a gift, especially after Friday's other key economic report -- durable goods orders for February -- also came in weaker than expected.

Following the reports, the market began pricing in fewer chances that the Fed will hike for much longer, after an expected quarter-point move to 4.75% next week.

Odds of such a hike stood at 100%, while odds of a move to 5% in May fell to 79% on Friday from 94% the previous day. The market still sees a 92% chance that the Fed funds rate will stand at 5% at the June meeting, which implies a pause in May. Odds of a 5.25% funds rate in June dropped to 0% from 6%.

Yet, caution still dominated trading on Friday ahead of the Fed's two-day meeting, which starts Monday.

The Dow Jones Industrial Average rose 9 points, or 0.09%, to 11,279, but well off an earlier high of 11,316.

The S&P 500 gained 0.1% to 1302. The Nasdaq Composite advanced the most, rising 0.6% to 2312, after Google ( GOOG) jumped 7% on news it will be added to the S&P 500.

Adding support to stocks, telecom-equipment suppliers Lucent ( LU) and Alcatel ( ALA) confirmed late Thursday they are holding merger talks, taking up were they left off five years ago.

For the week, the Dow was virtually flat, the S&P dropped 0.4% while the Nasdaq gained 0.3%.

The week started on a completely different tune for the "one-and-done" crowd. In a speech Monday night, Fed Chairman Ben Bernanke sounded more upbeat about the economy than the hopefuls would have liked. And on Tuesday, stronger-than-expected core producer prices even revived concerns that maybe the Fed will still hike three more times.

On Wednesday, news that Microsoft ( MSFT) delayed the launch of Vista, its new operating system, was largely overlooked by the market -- even if the delay is a blow to predictions of a capital spending boom this year.

On Thursday, data suggesting the housing market remained strong further fueled those fears. The National Association of Realtors said existing-home sales rose by 5.2% in February. In addition, homebuilder KB Home ( KBH) said first-quarter earnings rose 42% from a year ago to $174.5 million, or $2.02 a share, beating estimates by 6 cents a share.

It's hard to get a clear picture on the economy, given contradicting signals, especially from the housing market.

Bond pits are closely following the slowdown in housing to see whether it will weaken the economy enough to justify the end of the Fed's rate hikes, says Tony Crescenzi, interest rate strategist at Miller Tabak and a RealMoney contributor.

The view by the end of week was that it will. But the yield of the benchmark 10-year Treasury bond, which reflects inflation expectations, finished the week at 4.66%, roughly unchanged from the 4.67% on Friday of last week.

Economists view neither the existing-home sales data, which showed strength, nor new-home sales, which were weak, as telling the whole story.

Existing-home sales were likely boosted in February by warm weather the previous month. As for new homes sales, several economists noted that it was too early to say the February plunge marked a definitive acceleration in the slowdown.

"It is tempting to say that Chairman Bernanke should stop raising rates as to slow the deceleration in the housing market, but one month of surprisingly weak new home sales data does not constitute a market bust," writes Phillip Neuhart, economic analyst at Wachovia Securities.

The yield of the 10-year Treasury bond is used to benchmark mortgage rates and it has started rising over the past month or so. But the yield is still little changed from where it stood in June 2004, when the Fed first started raising rates.

Ending rate hikes would therefore be gearned not so much at preventing the housing market from slowing but to avoid slowing the rest of the economy too much. But the Fed will likely want to wait for more evidence of this weaker trend before ending rate hikes.
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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