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The Week Ahead: High Velocity (update)

Monday, 6 Aug 2007 | 12:43 PM ET

Like a power saw in overdrive, stocks will again cut a pattern of high velocity moves higher and lower in the coming week as investors look to see whether the Fed will hold out a hand to soothe the credit angst in financial markets.

Don't look for any move on rates, but there could be some adjustment of the language in the Fed's comments after it meets Tuesday. There is an increased focus on the Fed as new fear about the continued shakeout in the U.S. real estate market has investors looking for signs the Fed would step in if needed. By the end of last week, the credit crackdown had lenders jacking up rates on home mortgages after the quick collapse of American Home Mortgage.

As the credit constriction continues to shake markets, Wall Street has increasingly called for the Fed to jump in and many traders now see a cut by year end. The credit worries continue to create a flight to quality trade into Treasurys as rates rise in other parts of the credit market. The 10-year Friday was yielding 4.68% compared to 4.78% the week earlier.

"It's a forecast driven Fed," says CNBC senior economic correspondent Steve Liesman. "They will not cut to save markets. They could provide liquidity which is a little bit different."

Liesman said, however, if the economy ultimately shifts into low gear because of the markets, that would be a different story and the economy would be the driver of the Fed. "I wonder if there's a gathering sense within the Fed that housing is going to be worse for the economy than they thought," he said. "It could be a little below trend than they are already talking, but NOT recession."

The Fed has other tools it can use to help the markets ease up without moving rates, and we might see that come into play in the Fed statement Tuesday, he says.

"The Fed has an amazing number of words available in the English language to ease verbally," Liesman said. "They could say, even just including in the statement, that they notice the movements in the market and have been watching them for impact on the economy. That would be seen as dovish. Or they could back off their notion that inflation is the worst risk out there. I think the Fed will acknowledge the changed financial market reality Tuesday and take a step toward neutral but not go all the way there."

CNBC's Larry Kudlow agrees no action will be taken by the Fed, but a change in its tone would be helpful. He writes to us: "Fed on hold; no rate change. Credit markets are absorbing corporate and mortgage loan risks. Jobs and ISMs are Goldilocks; not too hot, not too cold; 2.5% growth with 4.6% unemployment and 1.9% core inflation. Good scenario. However, if Fed reaffirmed that it is fireman (lender) of last resort, and it is monitoring credit markets carefully for signs of any market dysfunction, that would be prudent. But markets are functioning, the temporary credit freeze is abating, and there's no need for any emergency actions."

Volatility Rules

The market's sharp ramp ups and then moves back down this past week are a trading pattern market pros expect to see for a while. On Wednesday, Blackrock's Bob Doll told Maria Bartiromo that the price decline in stocks is half way there but in terms of the time frame, there's still a ways to go. He said swings up and down will be typical as the market shakes out.

The Dow Jones Industrial Average posted a weekly loss of 0.7%, the S&P 500 ended down 1.8% and the Nasdaq Composite dropped 2.0%.

Vince Farrell, managing director at Scotsman Capital, says it would make sense for the Dow to bottom between 13,000 and 13,300. "A 50% retracement in the Dow would take it to 13,000," he said. "A three to five percent correction is very typical. That would be 13,300."

"Either way," says Farrell. "That's a very normal move. A 5% correction happens all the time."

"I've seen this movie before. I'm too old to let it bother me," he said.

We asked Farrell if he expects to see a big cleansing, whoosh downward before the markets settle down, and he said perhaps no because of the way big investors now hedge the market. "I see daily volatility of an extreme nature, but the daily volatility will drive you nuts...We'll be in the soup for a little while," he said.

Farrell, who is a CNBC contributor, said when the deal debt starts to clear and be successfully issued into the market, investors will start to focus on strong earnings and the fact that rates aren't that high. He also doesn't see the Fed making any moves soon either, and says in fact, it's better if the Fed doesn't have to move. "If this becomes a full blown crisis, which it's not, the Fed will ride to the rescue," he said.

The aversion to financial stocks only increased this week as rumors swirled around financial institutions and S&P put Bear Stearns on creditwatch. But Farrell said he likes some financials. He points to the stability of names like Bank America, and its big dividend.

He's not alone in his likes. CNBC's Bob Pisani wrote in his "Trader Talk" that Morgan Stanleystepped up and took advantage of the 10% decline in bank stocks to upgrade big cap bank stocks. Morgan says those stocks are already discounted and will rely on managing expenses and share buybacks to support earnings per share growth and to offset any further weakness in credit and margins.

By the way, those buybacks, along with buyouts, really are making an impact when it comes to taking stock out of the market. Trim Tabs Investment Research last week said the float of shares in the U.S. stock market dropped by a record $121 billion in July.

Econorama

The big drama this week is of course the meeting of the FOMC and its 2:15 p.m. announcement Tuesday, but there are a few other data points to watch for. Second quarter productivity and costs are due Tuesday morning, and consumer credit for June is released Tuesday at 3 p.m. New York time. Wholesale trade data for June is released Wednesday morning and the weekly jobless claims are out as usual Thursday. Import prices and the federal budget are Friday.

U.S. retailers report July sales on Thursday, and there's been a relatively light shopping season this summer. She told us earlier in the week that there's a lot of short activity in retail stocks.

"I think short interest is growing majorly now for two reasons. One, the market is betting consumers will slow their spending at mid to low end retailers during this already light summer shopping season, and secondly traders are shorting some of the retailers rumored to be takeout targets on news of the tightening credit markets," Brennan said.

Brennan says short interest in widely rumored takeover target Macy's is at 2.7% and specialty retailer theGapwhich was rumored to be a private equity target, is at 17.6 million shares or 2.2% short interest. Short interest at Wal-Mart is at 36 million or 0.9% of outstanding shares, Targetis at 22.6 million or 2.7%. Short sellers are even betting against those retailers expected to get a boost from back to school sales like Kohl's (3%) and Best Buy (9.7%), she says. (corrects earlier version that inaccurately described number of shares as percent of shares)

Retail is a key to consumer attitudes and spending health. So investors will be watching those reports closely.

Andy Brenner, co head of structured products and emerging markets at MF Global, says the consumer is the one to watch when it comes to the Fed, too. Consumers have been tapping their homes for spending power and as the real estate market continues to deteriorate and credit constraints affect borrowing power, consumers could pull back. "The Fed has to recognize the consumer and I think they have to start easing the in the fall," said Brenner. Brenner says the September would be too early, but he certainly expects a cut in the not too distant future.

This week, "the Fed needs to look concerned," he said.

Other events of note include weekly oil inventory data, released Wednesday. Oil had a wild ride of its own this week and it settled at $75.12, losing $1.70 a barrel on Friday.

Good News at Earnings Central

The stock market, for the most part, is ignoring the good news in earnings reports this quarter. According to Thomson Financial, earnings for S&P 500 companies are up 8.6% from the year ago period. So far, 66% of 399 S&P 500 companies reporting have beaten estimates, and only 18% missed. A few big companies are expected this coming week. Ciscoreports on Tuesday, AIG, News Corpand Sprint Nextelreport Wednesday. In the energy industry, Duke, El Paso, First Energyand PG&Ereport Tuesday. Dynegyreleases numbers Thursday.

China Rising!

CNBC takes us to China all week and will go deep inside what is a land of opportunity for companies around the globe. CNBC's Darren Rovell looks at the impact of the Olympics and the big business around the games which are scheduled a year from now. Squawk Box anchor Becky Quick traveled with Texas oilman Boone Pickens as he explored China first hand and discovers the obstacles investors could face. CNBC's Melissa Lee went inside Shanghai's red hot stock market and also looks at the possibilities and problems behind China's building boom.

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