Traders spent the week grappling with undeniably strong economic growth and the trouncing of rate-cut hopes.

With most of December's data in the hopper, the fourth quarter of 2006 has shaped up to be more of a barnburner than expected. Economists believe fourth-quarter GDP will reflect 3.3% growth, as the labor market remains robust, the housing market is working off its overbuilt inventory and the consumer is still spending.

In particular, new-home sales data this week showed that homebuilders are working down their inventories. Friday's durable goods orders reflect increasing capital spending outlays.

"Forget about the rate cut," says John Lonski, chief economist at Moody's Investors Service.

The markets have shifted into another set of expectations and risks, says Lonski. The expectations are for stronger growth -- closer to the 3% that economists call trend growth for the bulk of the year. But the risks include a possibly overheating economy, higher interest rates, and fears about inflation and fed funds rate hikes.

The Treasury bond market, which has been weakening all year, meaningfully broke down this week, sending yields higher and through a key resistance level at 4.85% on the 10-year note. The 10-year ended the week yielding 4.88%, up from 4.77% last Friday, and at its highest yield in five months.

The stock market handled the evolution in interest rates with a sloppy decline Thursday, just one day after the Dow Jones Industrial Average reached a new all-time high. All three indices finished the week down 0.6%. The Dow ended at 12,487.02, while the S&P 500 finished at 1422.18. The Nasdaq Composite finished the week at 2435.49.

Stock investors were coping not only with the Treasury bond market selloff, but with a strong rebound in commodities prices. Likewise, the market watched credit spreads (risk premiums on high-yield bonds) reach near-record lows, reflecting ample liquidity in the financial system -- another reason the Fed is unlikely to cut rates.

"The global economy is booming," writes Michael Darda, chief economist at MKM Partners, long a believer that the Fed would not cut rates.

The fed funds futures market wiped the rate cut off the table this week, according to Miller Tabak. Odds of a rate hike or cut at next week's meeting are nil, while odds have swung to a 1% chance for a hike in March and 2% odds of a hike in May.

The week began with traders frenetically moving in and out of commodities-related and technology stocks. The price of oil jumped sharply on Tuesday ahead of President Bush's State of the Union address. The administration said it would begin buying 100,000 barrels of oil a day to replenish the strategic petroleum reserve that was depleted after hurricanes Rita and Katrina. The president also said the government would double the size of the SPR to 1.5 billion barrels.

The price of a barrel of light, sweet crude oil ended the week up 6.7%, closing Friday at $55.47.

Fourth-quarter earnings season is strong overall, but investors are hearing companies provide weaker guidance than they are used to, which is dampening traders' spirits.

According to Thomson First Call, 68% of the 197 companies in the S&P 500 that have reported earnings are beating estimates. Thomson says 15% have matched estimates and 17% have come in below. The average over the past two years is 67% beat, 14% match and 19% miss estimates. Thus far, earnings are reflecting 9.9% year-over-year aggregate growth for the quarter.

Technology companies are beating estimates by the largest margin -- an average of 8%, says Thomson's John Butters, noting that Apple ( AAPL) and Microsoft ( MSFT) earnings particularly boosted that average.

But technology companies' earnings guidance for the first quarter of 2007 is similar to the overall earnings guidance so far, which is "pretty negative," says Butters. The ratio of negative-to-positive preannouncements (including companies not in the S&P 500) for the first quarter is 3 to 1. The average over recent quarters has been just under two negative to one positive.

Overall guidance for companies within the S&P 500 is even weaker, at six negative preannouncements to one positive, says Butters.

The soft guidance has shoved Thomson's first-quarter earnings growth estimates lower -- to 5.8% from 8.7% at the beginning of the year.

The market welcomed strong earnings reports from industrial farm-equipment maker Caterpillar ( CAT), whose stock soared 2.5% Friday and 2.8% for the week. Shares of its competitor Deere ( DE) jumped 1.2% Friday as well.

Other marquee reports this week included Ford ( F), which threw the proverbial kitchen sink at investors with its largest loss ever on Thursday. The company reported a $12.7 billion loss, but the stock wouldn't go down. Investors bet that this was the bottom for Ford, as it surged 2.4% Friday.

Microsoft also boosted investor confidence in the technology sector as its earnings beat estimates. Investors cautiously bought into the notion that the Vista operating system will lead to more revenue for the company and more economic growth in tech. Microsoft's shares gained 0.5% Friday, but remain down 1.6% on the week.

Next week is likely to be just as volatile as this one. The market will see its expectations and fears either proven or denied. The FOMC concludes its policy meeting on Wednesday. Among a slew of other reports, the government takes its first stab at fourth-quarter GDP growth, and Friday brings payrolls data and average hourly earnings. If the Fed is hawkish, the markets will start to err even further on the side of rate hikes and inflation fears. If the Fed remains status quo and growth is strong, the market could rally ... depending on its mood, of course.

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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 here to send her an email.