The Week Ahead: Inflation-Watch

Volatility is back with a vengeance, and investors will be watching next week's economic calendar carefully, with inflation data topping the list.

Wall Street this week remembered the prediction many traders made as the year began: 2007 would be a year of high volatility for stocks. This last week, the market delivered on that forecast. The Dow was down 3.5% by Thursday, but a 157-point rebound Friday took it to only a 1.8% loss for the week. The S&P, still setting records Monday, lost 1.9% on the week, and the Nasdaq finished off 1.5%.

Stocks had their worst week in 14. The punishing blow was Treasury yields' upward creep, aggravated by activity in credit markets as traders rushed to fix floating rates. The 10-year crossed the psychological barrier of 5% Thursday and finished out Friday with a yield of 5.119%, up from 4.955% at the end of the week prior. The dollar gained 0.6% against the Euro for the week.

Consumer price data for May (CPI) will be reported next Friday, while producer prices are due on Thursday. The other big number this coming week is May retail sales, which comes Wednesday.

"We're going to live or die on the inflation data. I'm expecting tame inflation data based upon the idea that the cost of home ownership is continuing to come down, and that's 40% of the core CPI," says CNBC's chief economics correspondent Steve Liesman. "It's going to be really hard to have too bad a number if that one component continues to decline."

Bond yields have been rising for several months as traders have interpreted recently stronger economic data as a sign the U.S. economy is firming up after a weak first quarter. Some traders have been worried about the Fed's inflation-fighting posture, and are looking at inflation as a possible driver of rates.

"This is about faster growth and higher earnings. It is not about inflation, and therefore it's a great time to buy into this stock market. The correction is long overdue," says CNBC's Larry Kudlow. "If I'm wrong, and inflation rises, then we'll have a really ugly selloff and it won't be orderly."

"All that talk about global inflation is a bunch of crap, in my humble opinion," says Kudlow. "Real interest rates are going up, inflation is not...the TIPS spread is telling you (that a) soft landing is giving way to better growth," he said

Tuesday is the NFIB small business survey for May, and then later in the day, the federal budget. Wednesday is a big day with retail sales for May, import prices and business inventories for April. The Fed's beige book is released at 2 pm.

The producer prices for May are released Thursday as well as initial jobless claims. Friday's big number is the CPI. Also that day are the current account for first quarter, the Empire State manufacturing survey for June, May's industrial production and University of Michigan consumer sentiment.

"We want to watch inflation and retail sales. But as important as all that is, we don't want to underestimate money capital flows. That mountain of liquidity that's out there is still powerful, but it doesn't go quite as far with higher rates. A lot of financing for M&A deals is not done yet either," says CNBC's Rick Santelli.

A big worry hanging over the market this past week was that rising rates may undercut the LBO boom may slow as buyers pay more to finance deals. As stocks rose Friday, takeover rumors flooded back into the market--along with buyers.

Fed Chairman Ben Bernanke will be the chief Fed speaker this week when he attends the Atlanta Fed's credit conference on Friday. The topic is the credit channel of monetary policy in the 21st Century. He will take questions after the speech, and it will be carefully watched. Cleveland Fed President Sandra Pianalto and ECB Governing Council member John Hurley speak on monetary policy perspectives in Dublin, Ireland on Monday. Chicago Fed President Michael Moskow speaks on the state of the U.S. car industry in Chicago Monday as well.

Other Fed speakers this week include San Francisco Fed President Janet Yellen, who gives a talk on the global economy Friday in Boston. Fed Governor Randall Kroszner speaks Wednesday morning at a public hearing on the Home Ownership and Equity Protection Act.

Treasury Secretary Hank Paulson speaks Tuesday morning at a conference on American Competitiveness hosted by Commerce Secretary Carols Gutierrez in Atlanta. The goal of the conference is to bring together business and government leaders to discuss ways to increase competitiveness in the Western Hemisphere.

Retired--but still closely followed--Fed Chairman Alan Greenspan speaks at a mortgage conference Tuesday in New York.

Conferences of interest next week include Goldman Sachs' Global Healthcare conference from Monday to Thursday; Bear Stearns' Technology and Internet conference in New York Monday and Tuesday; Citigroup's retail technology conference Tuesday, and the Needham Biotech conference Wednesday and Thursday.

CNBC pharmaceutical expert Mike Huckman covers an Alzheimer's conference Monday, where some analysts expect to hear data from Neurochem on its "make or break" Alzheimer's drug. Huckman says the Alzheimer's market is closely watched by Wall Street, and many big players are developing treatments. It's now a $1 billion market and could reach as much as $15 billion over the next couple of years, he says.

Apple holds its annual developers' conference Monday in San Francisco. CNBC's Mary Thompson will be there, and as a special event will do a real-time blog from the conference for CNBC.com. Apple is expected to show off its new Mac operating system at the conference.

It's that time of the quarter when the brokerage industry reminds us that the next earnings season is just around the corner. Lehman Brothers reports earnings Tuesday, and Bear Stearns and Goldman Sachs report Thursday. These earnings will be closely watched for what the brokers say about the markets, their investment banking income and their outlook.