The market rallied strongly over the past week on rising expectations that the central bank will not only cut rates when it meets Dec. 11, but that the move will be a half-percentage point -- more than the quarter-percentage point previously priced in by traders.
"We got into this rally with a nice bounce in financials on expectations that the Fed is going to cut rates in two weeks," said Paul Nolte, director of investments at Hinsdale Associates. "But we're facing a heavy week in terms of data."
A mixed performance on Friday still left the Dow Jones Industrial Average with its third-best weekly performance of 2007.
The Dow gained 59 points to end at 13,371 Friday. But for the week, the blue-chip average rallied 390 points, or 3%.
The rally began Tuesday, following a slide on Monday, after news that Citigroup Inc. received a $7.5 billion injection from the Abu Dhabi Investment Authority -- a welcome development as the banking giant continues to struggle with write-downs linked to bad home loans.
The broad S&P 500 Index saw its best four-day performance since March 2003. For the whole week, the S&P gained 2.7% to stand at 1,481 Friday.
The tech-heavy Nasdaq Composite Index rose 2.4% on the week to finish at 2,661. The Nasdaq still fell on Friday, as shares of Dell Inc. tumbled 13% after the computer maker reported slowing desktop PC sales along with a murky outlook.
Broad losses for November, however, reflected the market's continuing concerns about a resurgence of this summer's credit crisis. The Dow industrials ended November down 558 points, or 4%. The S&P 500 finished the month 18 points, or 4.3%, lower. The Nasdaq Composite lost 198 pts, or 6.9%.
"What we've seen was more of a relief rally from oversold conditions than a new leg higher in the market place," commented Nolte. "The credit problems haven't gone away, and the risk remains in financials. We're not out of the woods because nobody has any real sense of the depth and breadth of this situation."
Financials rallied over the past week after the Citigroup announcement gave hope for other financials. The Amex Securities Broker/Dealer Index rose 2.9% over the past week, led by the likes of Merrill Lynch & Co. , Bear Stearns Cos. and Goldman Sachs Group .
While a quarter-percentage point rate cuts is fully priced in by the market, bets that the Fed will cut by half a point rose to between 60% and 70% on Friday, according to Action Economics.
In a speech Thursday night, Fed Chairman Ben Bernanke placed emphasis on the renewed turbulence in credit markets and said that it had the potential to further slow housing and other credit-sensitive sectors of the economy. Similar comments by Bernanke's top deputy, Donald Kohn, led to a sharp stock-market rally Wednesday.
Bernanke said that the Fed would especially focus on the November unemployment report, which will be released Dec. 7, adding that the labor market remained "solid" in October, with 130,000 new jobs tallied.
Wall Street economists on average forecast job growth of under 100,000 for November.
"It's going to be a pretty interesting week," said Kim Rupert, a managing director at Action Economics. "Credit turmoil is going to remain very dominant, and with Bernanke saying that data will be key, we're not debating about whether the Fed is going to cut rates, but by how much."
"If the data come in pretty weak, then that would boost the case for a 50-basis points cut," she added.
On Monday, the market will focus on November manufacturing data from the Institute of Supply Management. Domestic-vehicle sales data for November also will come outon Monday.
Wednesday will see the release of the ADP private-sector employment report, along with third-quarter productivity data, October factory orders and pending-home sales, as well as the ISM's nonmanufacturing index.
The risk for stocks remain that expectations of a half-point rate cut might be trumped by stronger than expected or inflationary data, which might give the Fed some pause, analysts said.
However, many in the market remain encouraged that central bankers have mostly toned down their inflation-fighting rhetoric in recent weeks.
"We could be disappointed," said Rupert of Action Economics. "But with Bernanke and others fooling us a couple of times previously, stocks will continue to assume that the Fed is going to remain quite friendly."
By Nick Godt