US stocks: Fed and inflation top agenda

NEW YORK - The Federal Reserve is widely expected to raise US interest rates this week, so investors will scrutinise economic data for signs of inflation and focus on corporate outlooks for hints of weakness.

Stocks have been hammered this month by fears that the Fed will continue to raise interest rates in a bid to rein in rising prices. The Standard & Poor's 500 Index has fallen 2.5 per cent so far in October -- with just one trading day left.

So any whiff of inflation in either the Personal Consumption Expenditure (PCE) index due on Monday or the manufacturing survey from the Institute for Supply Management due on Tuesday may send stocks skidding.

"I would say that core PCE is going to be a big focus at the beginning of the week," said Richard Hoey, chief investment strategist at Dreyfus Corp. "The PCE is important because that is what the Fed is focused on."

The Fed's rate-setting body, which has already raised its fed funds rate to 3.75 per cent from just 1.0 per cent in mid-2004, will announce its rate decision on Tuesday.

Economists polled by Reuters expect the Federal Open Market Committee to raise interest rates another 25 basis points to 4.0 per cent at this meeting.

"(This) week is all about the Fed," said Michael Metz, chief investment strategist at Oppenheimer Holdings Inc, in New York. "But we all know they are trying to bring back the benchmark rate to neutrality. They still have a couple more rate increases to go."

The Fed is also expected to leave the language in its statement released on Tuesday largely unchanged, although it will be closely watched.

Stocks also may get a bounce early in the week as the month of October comes to a close on Monday and cash is put to work in the equity market.

"Usually, there's a seasonal pickup in buying as cash flows come in," said Fred Dickson, chief market strategist at D.A. Davidson & Co.

For the past week, stocks gained. The blue-chip Dow Jones industrial average climbed 1.84 per cent for the week, while the technology-laced Nasdaq Composite Index advanced 0.37 per cent. The broad Standard & Poor's 500 Index rose 1.60 per cent.

Although most companies in the Standard & Poor's 500 index have already reported third-quarter earnings by this week, there are still plenty of reports to come.

Big companies on deck to report results include health insurer Humana Inc., cereal maker Kellogg Co., Valero Energy Corp., video game maker Electronic Arts Inc., Procter & Gamble Co., the bellwether consumer products company, and media company Time Warner Inc.

Of the 347 S&P 500 companies that have reported so far, nearly 70 per cent have topped Wall Street profit forecasts, while only 18 per cent have fallen short, according to data compiled by Reuters Estimates.

"Earnings are coming in 'in line' with expectations. We should still be up 15 per cent year-over-year and that's better than we did in the first half," said Alfred Kugel, chief investment strategist at Atlantic Trust/Stein Roe in Chicago.

Even so, investors will keenly watch companies' earnings outlooks. The majority have been cautious so far, as high energy costs crimp profits and hurt household budgets.

Other important economic reports for equity investors this week include October auto sales on Tuesday, October retail sales on Thursday and the Labor Department's jobs report for October on Friday.

- REUTERS