What Is The Fed Watching Now?

The Philadelphia Fed's index of business activity in the Mid-Atlantic region came out weaker than expected, and follows a drop in the New York Fed's manufacturing index. Will this overshadow a surge in wholesale inflation when the Fed makes a decision on interest rates next week? We picked the brains of two market pros.

"I think there is a great deal more worry among investors of the possibility of persistent home price deflation than there is about a somewhat faster rate of core price inflation," said John Lonski, chief economist at Moody's Investors Service. "The former has the potential to do considerable damage to the economy, while the latter … probably won't have much of an economic impact at all."

"The troubling news on the core PPI warns all of us that once housing stabilizes sufficiently, investor attention will quickly turn to a rate of core inflation that is faster than the Fed wants," he said. "Thus, we may be bracing for a Fed rate hike later this year or early next."

Lonski added that he thinks there is still a chance for a rate cut, which would then be followed by a couple of rate hikes in early 2008.

Mike Englund, chief economist at Action Economics, says the strong inflation data will force the Fed to maintain its tightening bias.

"The Fed started with very aggressive rhetoric that they would focus on inflation numbers and we really don't see those numbers dropping into the comfort zone anytime soon," said Englund. "So unless rate cuts are dictated by some sort of housing problem, the pressure will increase on the Fed to do something about inflation."

The monthly Price Producer Index in February jumped 1.3%, while the core rate rose 0.4% following two consecutive 0.2% gains, sparking inflation concerns.