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What's casting a pall over stocks

Equities moved lower again on Wednesday, with the Dow Jones industrials closing down 1.6 percent, or 292 points, and slipping back below its 50-day moving average. This is the first time that key level was in play since the Federal Reserve spurred the bulls on last week by halving its estimate of the number of interest rate hikes it expects this year from four to just two.

Ostensibly, the catalyst for the decline was another batch of disappointing U.S. economic data. This time, it was durable and capital goods orders, which all fell more than 1 percent. Orders for nonmilitary capital goods excluding aircraft -- a proxy for future business investment spending -- suffered its sixth consecutive monthly decline, the longest losing streak since 2012.

The S&P 500 also took a dive with a 1.5 percent lower close at 2,061. Combine that with a Nasdaq-crushing (down 2.4 percent today to 4,877) pullback in biotech stocks, which have been seeing intense speculative energy lately, and a pall has been cast over the market. But will it last?

As has been the general rule of this bull market, much depends on the Federal Reserve.

You see, poor economic news has generally been considered a positive for this liquidity-addicted stock market because it increased the odds of additional monetary policy easing and an extended reign of ultra-low interest rates.

But that hasn't been the case this week as Fed officials have been out in force buttressing expectations of rate hikes this year and largely dismissing recent economic weakness as weather-related and a slump in inflation as caused by transitory factors. This comes as the Atlanta Fed's GDPNow real-time forecast of first-quarter GDP growth falls to just 0.2 percent.

The concern is that the Fed is not publicly acknowledging the downside risks of a global deflationary impulse and economic slump: We've seen weak economic results out of Japan and China this week, for instance. Moreover, since the beginning of the year foreign central banks have made 27 separate interest rate cuts.

And while weather-related forces led first-quarter 2014 GDP growth into negative territory, the current slump is deeper by some measures -- such as the U.S. Citigroup Economic Surprise Index -- suggesting that perhaps today's weakness reflects structural problems rather than just snow falling in winter.

Stocks, as represented by the NYSE Composite Index, are contending with massive overhead resistance going back to last summer. If the Fed softens its tone, we could see a breakout leading to an easy-money, currency-driven meltup. We've seen them all across foreign markets this year -- in China, Japan, Germany and elsewhere -- but not yet in the U.S.

But if the Fed surprises by hiking rates for the first time since 2006 at its June meeting, thing will get ugly fast.

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