The latest economic data continues to show a mixed bag, with business activity falling sharply in the Midwest but consumer spending nationwide showing strength.
In the day's biggest surprise, the Chicago Purchasing Managers Index skidded to 49.9 in November from 53.5 the month before. Economists had forecast an increase to 54.0. A reading below 50 indicates contraction. Coming into November, the Chicago PMI had been above 50 for more than 3 1/2 years.
Meanwhile, the Commerce Department said consumer spending rose 0.2% in October, the best showing in three months. Spending had fallen by 0.2% in September and posted only a slight 0.1% rise in August.
The spending increase was bolstered by continued solid growth in incomes, which rose by 0.4%in October, reflecting solid employment growth that pushed the jobless rate to a five-year low.
A price gauge linked to consumer spending--and closely watched by the Federal Reserve--posted a 0.2% rise in October. This price barometer, which excludes food and energy, is up 2.4% over the past year, still higher than the Fed's comfort zone.
Also, the number of Americans filing new claims for unemployment benefits posted an unexpectedly large increase last week, rising by 34,000 to 357,000, the Labor Department reported.
Speculation About Interest Rates
The unexpected drop in Midwest business activity hit stocks and renewed speculation that the Federal Reserve may need to cut interest rates sooner than later to give the economy a boost.
"It is clear that manufacturing is losing momentum," said Carl Tannenbaum, chief economist at LaSalle Bank/ABN Amro in an interview on CNBC's "Morning Call."
"Inventories are rising and the puzzling thing... is that consumer spending has not really rebounded with the drop in gasoline prices and the rise in the stock market," Tannenbaum said. "So clearly the home correction is having an impact."
The Federal Reserve is hoping that its two-year campaign to raise interest rates will cool consumer spending and the overall economy enough to keep inflation under control but not do so much damage that it pushes the country into a recession.
More marketwatchers expect the Fed to hold off on further interest rate hikes for now. For example, Lehman Brothers no longer expects an increase in the first quarter. Still, others think it's still possible the Fed could cut rates in March.
"A lot of people forget that inflation is a bit of a lagging indicator," said Mark Vitner, senior economist at Wachovia on CNBC's "Morning Call." "Some of the run-up in the core inflation measures that we are seeing now relects the past strength in the housing market and housing is clearly cooling off."
Vitner expects a rate cut is possible in March based on his expectations for much lower growth in in the gross domestic product in the fourth and first quarters.
Consumer Spending Stronger
The 0.2% rise in consumer spending was the best showing since a 0.8% jump in July, a month when Americans flocked to auto showrooms to take advantage of attractive sales incentives.
The October spending gain looked even better when the impact of a big drop in gasoline pump prices was removed. Inflation-adjusted spending was up 0.4%.
Many investors will be monitoring consumer spending closely because it accounts for two-thirds of total economic activity. Americans slowed their spending activity sharply in the spring and summer as they struggled to deal with the impacts of soaring gasoline prices, rising interest rates and a cooling housing market.
After starting the year at a torrid rate of 5.6%, overall economic growth slowed to 2.6% in the April-June period and even further to a pace of just 2.2% in the July-September period. However, that 2.2% growth rate reported on Wednesday represented a revision from an initial estimate of just 1.6%.
That upward revision has bolstered the view that the economy will avoid an outright recession even though the slump in the once-booming housing market is proving to be more serious than economists had anticipated.
Federal Reserve Chairman Ben Bernanke said Tuesday that economic growth, outside
of autos and housing, remained "solid."