By Jennifer Yousfi
Managing Editor

Real gross domestic product (GDP) increased at an annual rate of 0.9% in the first quarter, the Bureau of Economic Analysis (BEA) announced yesterday (Wednesday).

“We are somewhere in the twilight zone between an expansion and a recession,” Michael Feroli, an economist at JPMorgan Chase & Co. (JPM) in New York, told Bloomberg News. “We will have a poor pace of growth through the year.”

The preliminary estimate of GDP represents an increase from the Apr. 30 advance estimate of 0.6% and is based on more complete economic information.

Economic expansion was primarily due to a boost in exports due to the combination of a weak dollar and strong overseas sales. Imports also declined, as the trade deficit shrank to its lowest level in five years.

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The slight boost in GDP could be just what the U.S. Federal Reserve needs to hold off on any further interest rate cuts.

“The underlying domestic demand in the economy showed slight improvement. It’s probably consistent with the Fed being on hold in June and several months after that,” Nick Bennenbroek, currency strategist with Wells Fargo & Co. (WFC) in New York, told Reuters.

The Fed’s aggressive rate-cutting campaign has brought the Fed Funds rate down to 2.00% from 5.25% last September. But while it seems the cuts are helping the U.S. economy skirt a true recession – defined as two consecutive quarters of negative GDP growth – those same cuts have added fuel to the inflation fire.

The minutes of the last policymaking Federal Open Market Committee (FOMC) meeting showed that the Fed’s inflation forecast was raised from a range of 2.1%-2.4% to a range of 3.1%-3.4%.

And many analysts, including Money Morning Contributing Editor Martin Hutchinson, feel the Fed will need to raise rates to combat that escalating inflation.

“The nation’s central bank will soon have to reverse course and start raising interest rates – and probably in a hurry, too, if the Fed wants to keep oil prices on this side of the stratosphere,” Hutchinson said in a recent Money Morning investment analysis.

And with the economy still growing, even at a sluggish pace, the Fed might be able to take Hutchinson’s advice. The upward revision to GDP comes close on the heels of other recent economic reports that were better than expected, including April durable goods orders and April retail sales.

“Data reported so far point to continued expansionary growth in the second quarter,” Sam Bullard, a Wachovia Corp. (WB) economist in Charlotte, North Carolina, said in a research report, Reuters reported.

The economic stimulus checks sent out to over 130 million U.S. households could provide a nice boost to the economy. If consumers spend that money, rather than using it to pay down debt or pad their savings, it could turn into a nice shot of growth for GDP in the second quarter.
The third (and final) estimate for first quarter GDP will be released on June 26.

News and Related Story Links:

• Bureau of Economic Analysis:
  Gross Domestic Product: First Quarter 2008 (Preliminary)

• Bloomberg News:
  U.S. Economy Expands Faster Than Previously Estimated

• Reuters:
  GDP growth revised higher, Central bankers projected that prices would rise in 2008 at an annual rate of 3.1 percent to 3.4 percent, far faster than the year before. jobless claims up

• Money Morning:
  GDP Holds Steady at 0.6% in the First Quarter

• Money Morning:
  Is the Fed Fueling the Inflation Fire?

• Money Morning:
  With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play

The U.S. economy averted recession in the first quarter, as real gross domestic product (GDP) for the U.S. economy grew 0.6% in the first quarter, the Bureau of Economic Analysis announced yesterday (Wednesday).

"The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE) for services, private inventory investment, exports of goods and services, and federal government spending that were partly offset by negative contributions from residential fixed investment and PCE for durable goods" the statement read.

The advance figure represents the first of three estimates for first quarter GDP that will be released and was unchanged from the final fourth quarter estimate of 0.6%. But despite the unexpected growth, there was little good news for the economy in the report.

"No one would confuse this with a healthy economy," wrote Douglas Porter, an economist for BMO Capital Markets, MarketWatch reported.

The estimate was three times the mean expected rate of 0.2% growth, and economists seemed to agree the difference was due to the unexpected growth in inventories in the month of March. Analysts were quick to warn that if domestic companies do not sell through the current inventory backlog, it could mean weakness in the coming quarters.

"If you were to take out the swing in inventories, these numbers would be negative," MarkVitner, senior economist at Wachovia Corp. (WB) in Charlotte, North Carolina, said in an interview with Bloomberg Television. "We think we’re in recession, but I don’t know that the GDP numbers are going to turn negative at all in 2008."

Positive GDP for the first quarter might mean the United States hasn’t fallen into a textbook recession, but many economists feel the financial environment continues to deteriorate. [Please click here for a related story in today’s issue on the U.S. Federal Reserve’s rate cut decision yesterday, due to the current state of the economy.]

"Without a doubt, some will find reason to celebrate that we avoided a recession in the first quarter," Bernard Baumohl of the Economic Outlook Group, told Forbes, adding that the economic and financial crises are not over. "We may not be formally in a recession based on the preliminary GDP data (but) there should be no doubt this country is struggling within a recessionary environment."

Indeed, while the economy produced more goods and services in the first quarter, many of those goods ended up in warehouses without translating into sales. It’s unlikely we’ll see a similar buildup of inventory in the second quarter, which would translate into lower or negative GDP growth for the quarter ended June 30.

"The consumer is pulling back," Nigel Gault, chief U.S. economist at Global Insight Inc., a Lexington, Massachusetts-based forecasting firm, told Bloomberg. "We are probably going to have a negative second quarter as businesses start running down inventories. Weakness in housing will continue."

The one thing that could boost second quarter GDP are the economic stimulus checks being sent out to over 130 million U.S. households. If consumers spend that money, rather than using it to pay down debt or pad their savings, it could turn into a nice shot of growth for GDP in the second quarter.

"If households keep spending, even modestly, it is likely that growth in the second quarter will be positive as well," said Joel Naroff, president and chief economist of Naroff Economic Advisors in a note to clients yesterday.

However, Naroff added that the stimulus checks were a temporary fix and "we could see a relapse once the government-induced sugar high disappears." 

The advance GDP estimate is based on data that is either incomplete or subject to possible revision. The second "preliminary" estimate of GDP will be released May 29.

News and Related Story Links:

• Bloomberg News:
  U.S. Economy: Gross Domestic Product Expanded 0.6%

• MarketWatch:
  U.S. economy grows 0.6% in first quarter

• Forbes:
  Sluggish U.S. growth keeps economists debating about recession declaration

If U.S. Federal Reserve policymakers make the expected quarter-point rate cut at the end of their meeting today (Wednesday), the impact will be felt well beyond U.S. borders.

Indeed, the interest-rate reduction could set in motion a series of diverse global events that will impact such seemingly unrelated areas as European inflation, global food prices, the U.S. dollar, American exports, and the already chilly relationship between the European Central Bank (ECB) and the government of France.

For any of this to happen, however, the Fed first has to act. Most observers believe the U.S. central bank’s policymaking Federal Open Market Committee (FOMC) will reduce the Federal Funds rate for the seventh time since mid-September, dropping the benchmark borrowing cost from 2.25% to 2.0%.

According to many experts, the Fed’s timing will be excellent. Economists have increasingly come to believe that the U.S. economy is probably in a recession already, although most await more-certain evidence before actually making the pronouncement.

Some of that evidence could come out today. U.S. stocks traded in a narrow range yesterday (Tuesday) as the market awaited two important announcements: The advance estimate of U.S. Gross Domestic Product (GDP) and the central bank’s rate-reduction decision – both due out today.

"Another large batch of companies has reported quarterly earnings results, but overall, they have failed to move the needle that much as the market is in a wait-and-see mode ahead of the GDP data and the FOMC decision on Wednesday," Patrick O’Hare at Briefing.com Inc. told the AFP news service.

There are some strong dissenters.

"There is no reason why the Fed should be cutting rates right now," Richard Yamarone, director of economic research at Argus Research Corp., told MarketWatch.com.

What Tales GDP Doth Tell

Although GDP is a lagging indicator, analysts anxiously await the report since it will demonstrate whether the U.S. economy is as weak as many believe. According to a Reuters‘ poll, first quarter GDP is expected to clock in at a sluggish 0.2%, down from a 0.6% growth rate in the fourth quarter. Reuters developed the consensus estimate by averaging 89 predictions, which ranged from contraction of 0.8% to growth of 1.5%.

Most analysts, including those at UBS AG (UBS) and Lehman Brothers Holdings Inc. (LEH), felt March’s surprisingly strong durable goods orders and an increase in inventories would tip the balance in favor of slim growth in the first quarter. However, analysts did note that inventory increase could signal weakness ahead, especially if not supported by the accompanying increase in sales needed to create the "sell through" that would keep additional inventories from piling up.

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"A $5 billion accumulation of [inventories] would add almost a full percentage point to GDP growth and, in our forecast, constitutes the difference between a positive and a negative result," RBS Greenwich Capital said in a note to clients.

A positive GDP estimate, however slight, could mean the U.S. economy is poised to skirt a true recession. The textbook definition of a recession is two consecutive quarters of negative GDP growth.

But the weak GDP estimate, which will be announced early this morning, could prove the justification the FOMC needs to recommend another rate reduction this afternoon.

CME Group Inc.’s (CME) Chicago Board of Trade futures are pricing in an 82% chance that the FOMC will recommend the U.S. Federal Reserve make a quarter point cut, bringing its key interest rate down to 2.0%. When the Ben S. Bernanke-led central bank started its rate-cutting campaign last year, the Fed Funds rate stood at 5.75%.

And if policymakers do order the rate-reduction, most analysts believe it will be the last one for awhile; those same CBOT futures indicate a 71% chance that the Fed will hold the line on interest rates when the committee meets again in June.

"The direction of Fed policy hangs in the balance, and there are people like me that hope the central bank quits sooner rather then later," Jack A. Ablin, chief investment officer at Harris Private Bank, told The New York Times.

But here’s where the global wild cards come into play.

When Everything’s Wild

With its ambitious rate-cutting strategy, the Fed has stoked domestic inflationary pressures and helped accelerate the decline of an already-sinking dollar.

Officially, the U.S. inflation rate stands at about 4%, though many experts – including Money Morning Contributing Editor Martin Hutchinson – believe the actual U.S. inflation rate is much higher. In fact, anyone who studies the sharp increases in energy, food prices, commodities, healthcare, and a university-level education may find it tough to argue that prices aren’t headed higher.

Even with a bit of a rebound, of late, the dollar is down more than 7.3% against the euro in the past six months, 12.35% in the past 12 months and nearly 28% in the last 54 months. The greenback is down substantially against other key currencies, too, and that’s helped fuel a massive run-up in the cost of energy and food-related imports – all highly inflationary for U.S. consumers.

At the same time, however, the cheap dollar has made U.S. exports very competitive abroad. Indeed, for foreign buyers of such big-ticket products as Boeing Co. (BA) jetliners, the plunging dollar has served as a global blue-light special. Boeing’s bureaucratic arch-rival, Airbus SAS, hasn’t been able to compete, and a week ago was actually forced to raise prices on two of its commercial jets – citing rising steel prices and a falling dollar as the two key causes.

On Sunday, French Economy Minister Christine Lagarde said the gap between the U.S. and Eurozone interest rates was way too large, and called for a change in interest-rate policies – either by the Fed or the European Central Bank (ECB).

The U.S. Fed has been slashing rates to jump-start economic growth while also keeping a horrid housing market from putting the entire economy to sleep. The ECB, by contrast, has kept rates high to combat inflation – even though that strategy is pushing Europe into an undesirable slowdown.

"We are in a delicate situation where we have, on the one hand, an American Federal (Reserve) which has a policy of very low rates and a European Central Bank which has maintained high interest rates," Lagarde told LCI Television and RTL Radio, the global wire service Reuters reported. "The differential in interest between the two, it seems to me, is a little too big at the moment."

Paris has long been a vocal critic of what French President Nicolas Sarkozy has termed the ECB’s overly narrow focus on fighting inflation. But Sarkozy and Co. have been criticized by both Germany and the ECB for attempting to meddle in the business of a supposedly "independent" central bank.

With Eurozone inflation running at about 3.6% – its highest rate since the measure for that portion of the European market began in 1997, the European Central Bank (ECB) has left its key refinancing interest rate unchanged at 4.0%, despite some very definite signs that Eurozone growth is slowing.

The European Commission, the executive branch of the European Union, said Monday that Eurozone growth would continue to erode throughout 2008 and 2009. The EC said the combined economic growth rate for the 15 countries that use the euro would slow to 1.7% this year and 1.5% next year. The EC has cut its growth projections twice since November.

But here’s perhaps the biggest wild card: Inflation will climb to 3.2% this year, more than it previously forecast and well outside the group’s comfort zone of just under 2%. And it’s not expected to throttle back until late next year. For that reason, the commission remains focused on inflation, which it considers "the main problem that we have to face in the short term."

According to the EC, "the recent sharp rises in food and energy prices have depressed households’ purchasing power and consumer spending in the last quarter of 2007 and are expected to continue to do so during most of 2008," the commission said.

That may have to change. And here’s why.

Another cut in the U.S. Fed Funds rate will cause the dollar to skid and inflation to escalate still more, giving U.S. exporters an even bigger advantage over European rivals.

Dollar-denominated commodities such as oil, metals and food will continue to escalate in price. Initially, it will appear only as if U.S. exporters are just gaining an ever-larger advantage over their counterparts in Europe. European corporate profits – and stock prices – will start to feel the squeeze.

Sarkozy and Co. will step up their lobbying efforts against the EC and ECB – pushing for the rate reductions needed to restore parity with Europe’s economic rival across the Atlantic – making the French president even less popular.

In time, the EC and ECB will realize that this is not a temporary competitive disadvantage, but instead is a full-fledged slowdown. Even worse, it’s not a conventional slowdown, for Europe’s growth is declining steeply, even though inflation is escalating.

In short, the European economy has been afflicted with stagflation, something not seen since the 1970s in the United States.
Surprisingly, the question no longer is: What does Europe do? Instead, the first major moves will fall to the U.S. central bank, which will have to start boosting rates to draw the over-abundant liquidity from the financial markets and tame inflation.
But the process could take some time.

A Bullish View

Few mainstream economists see such a dour outcome for the Fed’s rate-cutting strategy.
Right now, they note, the battered U.S. greenback is poised to post its strongest month against the euro in nearly a year on anticipation that the Fed might be ready to end its rate-slashing campaign.

"If the Fed is not at the end of the easing cycle, it’s near the end," Jeff Gladstein, global head of foreign-exchange trading at AIG Financial Products (AIG) in Wilton, Conn., told Bloomberg News. "I don’t think the dollar will strengthen aggressively by any stretch, but I do think it’s trying to bottom."

The dollar has risen 1% against the euro in April and almost 4% against the yen during the same period.

But even those economists temper their optimism. The weak dollar is taking its toll, as commodities (many of which are dollar-denominated) continue to soar. It is likely the Federal Reserve hopes the softening U.S. economy will dampen demand and help to keep inflation in check. But if the current economic contraction does nothing to bring down soaring food and fuel prices – even if Europe doesn’t fade badly – the Fed will have no choice but to reverse course and raise rates to battle inflation.

At least two Federal Reserve Bank presidents are more concerned with inflation than growth. Richard Fisher, president of the Federal Reserve Bank of Dallas, and Charles Plosser, president of the Federal Reserve Bank of Philadelphia, both voted against lowering rates at the last FOMC meeting.

"Really, what we’re dealing with are inflationary expectations," Fisher said in an interview last week with Fox Business News, The Philadelphia Inquirer reported.

"And what we’re trying to make sure doesn’t get out of control," he said, "are the expectations of consumers and businesses, the way they price their behavior, the way they conduct their businesses, to begin imputing certain inflationary patterns, because then they’ll be exacerbating inflation, and that’s something certainly none of us wish to see."

[Editor's Note: Money Morning Associate Editor Jason Simpkins contributed to this article.]

News and Related Story Links:

• AFP:
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• Money Morning News Analysis:
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The U.S. economy only grew 0.6% in the fourth quarter of 2007.

"The credit crunch and rising inflation teamed to put the economy flat on its back in the final three months of 2007," IDEAglobal economist Joseph Brusuelas told Thomson Financial News.

The U.S. Bureau of Economic Analysis released its final estimate of Gross Domestic Product (GDP) for the three-month period spanning October to December yesterday (Thursday). The final estimate, an increase of 0.6%, was unrevised from the preliminary estimate released last month.

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"The deceleration in real GDP growth in the fourth quarter primarily reflected a downturn in inventory investment and decelerations in exports, in federal government spending, and in [personal consumption expenditures] that were partly offset by a downturn in imports," the BEA said in its statement.

The final estimate is a marked decrease from the 4.9% increase in GDP for the final estimate of third quarter 2007.

"It’s hard to see any good news at all,” Nariman Behravesh, chief economist at Global Insight Inc., a Lexington, Mass. forecasting firm, told Bloomberg News. "Housing is still dropping like a stone and now the consumer is slowing too. That’s the big difference" from the third quarter.

The advance estimate for first-quarter 2008 GDP growth is slated for release on April 30, and economists are estimating a flat reading.

"The fate for 2008, I think, was set some time ago,” Don Drummond, chief economist at Toronto-Dominion Bank in Toronto, said in a Bloomberg Radio interview. "Growth is going to average 0.0. It’s flat. Maybe it’s going to be a tiny negative or maybe it’s going to be a tiny positive."

News and Related Story Links:

• Bloomberg:
  U.S. Economy: Growth Slowed in Fourth Quarter as Housing Sank

• Forbes:
  US Q4 final GDP unrevised at 0.6 pct, corporate profits fall UPDATE

The preliminary gross domestic product (GDP) figure for the fourth quarter of 2007 was 0.6%, unchanged from the advance figure released last month, the Commerce Board announced yesterday (Thursday).

Analysts had expected a slight upward revision in GDP to 0.7% and the confirmed lower figure sent markets tumbling.
 
At yesterday’s New York close, the three major U.S. stock indices had all posted losses. The blue-chip Dow Jones Industrial Average Index had a decline of 112.10 points (-0.88%), to trade at 12,582.18. The tech-laden Nasdaq Composite Index slipped 22.21 points (-0.94%), to reach 2,331.57. And the broader Standard & Poor’s 500 Index dropped 12.34 points (-0.89%), to settle at 1,367.68.

In his second day of Congressional testimony, Federal Reserve Chairman Ben S. Bernanke acknowledged the difficulties the economy is facing.

"We are facing a situation where we have simultaneously a slowdown in the economy, stress in financial markets, and inflation pressures coming from these commodity prices abroad," Bernanke said.

However, the Fed Chief was quick to put stagflation concerns to rest as he does not feel "we are anywhere near the situation that prevailed in the 1970s."

"I don’t anticipate stagflation," he said.

"We have to make our policy trying to balance these different risks in a way that can get the best possible outcome for the American economy," Bernanke said. "At the moment, I think the greater risks are to the downside, that is to growth and to financial markets."

The prospect of further rate cuts weren’t enough to bolster the markets in the face of a faltering fourth quarter GDP, but it was enough to send the greenback to a new record low versus the euro. One euro is now worth $1.52 [conversely, one dollar is now worth 0.657 euro].

"There is very real concern that there is a possibility of a dollar crisis," said Paul Chertkow, head of global currency research at Bank of Tokyo Mitsubishi UFJ Ltd. (MTU) in London, in an interview with Bloomberg Radio. "I don’t use the word crisis lightly; we are in uncharted territory for the dollar, especially against the euro."

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• Bloomberg:
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Consumer confidence has reached its lowest level since the post-Katrina period, according to the Reuters/University of Michigan preliminary index of consumer sentiment for November.

At 74.5, the index is at its lowest level since October 2005. This is bad news for Wall Street, which hopes that strong consumer spending will keep the economy from slipping into a recession.

“Rising prices for fuel and food had a devastating impact on household budgets, and falling home prices have diminished consumers’ sense of financial security,” said Richard Curtin, the director of the Reuters/University of Michigan Surveys of Consumers. The survey is jointly developed by the university and a unit of Reuters Holdings PLC (RTRSY).

Other measures of consumer confidence reported similar results. The Royal Bank of Canada’s (RY) RBC Cash [Consumer Attitudes and Spending by Household] Index, also released Friday, was 65.9 for the month. This was a slight increase over October’s reading of 64, but not a large enough increase to indicate a substantial upswing in consumer confidence.

Because consumer spending accounts for as much as 70% of all economic activity in the $13 trillion U.S. economy, consumer confidence is a closely watched indicator. High consumer confidence is considered a harbinger of future growth, while declining confidence is viewed as a warning that economic activity is destined to slow. Although the indicator’s current level isn’t low enough to suggest that a recession is imminent, the Reuters/University of Michigan index has dropped steadily over the past several months. 

“This month’s decline reflects the fallout from the ongoing housing-market correction, the turmoil in the subprime market, the volatility in the stock market and rising gasoline prices,” Steven Wood, president of Insight Economics LLC in Danville, Calif., told Bloomberg News.

The continued tightening of lending standards has reduced the availability of credit, making it tougher for some consumers to finance bigger-ticket purchases. In addition, consumers are trying to pay down debt and build up emergency cash reserves in the event economic conditions only continue to get worse.

“Consumers have become more prudent and more interested in rebuilding their reserve funds as a precaution against any future adverse economic developments,” added Curtin, the Reuters survey director.

Several retailers are expected to miss fourth-quarter sales predictions. While Wal-Mart Stores Inc. (WMT) and some other discount firms have lured shoppers with heavy price reductions, such other chains as J.C. Penney Co. Inc. (JCP) and Target Corp. (TGT) posted disappointing November results, Bloomberg reported.

News and Related Story Links:

• RBC:
  The RBC CASH Index November News Release.

• Bloomberg:
  U.S. Michigan Consumer Sentiment Index Falls to 74.5.

• Associated Press:
  Consumer Confidence Near Two-Year Low.

• Wikipedia:
  Hurricane Katrina.

A mixed report from the Commerce Department indicates the U.S. economy continues to grow even as corporate profits start to show the strain of a weakening domestic market.

The report cited preliminary estimates for third quarter 2007 gross domestic product (GDP) and corporate profits. GDP was revised upward to 4.9%, an increase from the advance estimate of 3.9%. This is the largest increase at an annual rate for 2007 year-to-date, up 1.1% from the second quarter increase of 3.8%.  Investment in inventories and exports were the key contributors to the increase for the quarter. 

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Meanwhile, corporate profits from current production dropped $19.3 billion for the quarter. Domestic profits declined $41.2 billion, of which financial corporations accounted for over 70% of the decrease with a decline of $29.1 billion over second quarter.

The decline in financial profits does not even include the large write-downs recently taken by many banks to account for sub-prime related investments.

Profits from outside the U.S. showed the only signs of growth, posting a positive $21.9 billion, a $5.2 billion increase over second quarter. 

Leading economists are still at odds over what this means for the economy.  Some feel the decline in corporate profits is the first sign of a coming recession.

"The earnings recession has already arrived.  We are going to see an economic recession in ‘08," David Rosenberg, North America economist for Merrill Lynch & Co. told Bloomberg. 

Others remain optimistic that the economy will be able to skirt the textbook definition of a recession: Two consecutive quarters of negative GDP growth. 

"We continue to see signs of healthy economic growth, which only underscores the resilience of our economy despite continued challenges in the housing sector," White House chief economist Edward Lazear said in a statement released last Thursday, the same day the GDP and corporate profit numbers were released. 

Fourth quarter’s GDP number is likely to be weaker, as inventory expenditures will be lighter after the third quarter build-up. And it is unlikely foreign profits can remain strong enough to compensate for falling domestic profits as international markets also begin to feel the effects of the softening U.S. economy.

The market is counting on another rate cut at the Fed’s December 11th meeting, but even a 50-basis point cut may not be enough to offset the ever-mounting list of economic concerns. 

News and Related Story Links:

• Money Morning:
  Money Morning’s Three-Minute Market Review: How Last Week’s Action is Shaping This Week’s Market

• Bureau of Economic Analysis:
  Advance Estimates of Gross Domestic Product

• Bloomberg:
  Recession Hits U.S. Profits; Economy Might Be Next

• Market Watch:
  U.S. GDP revised up to 4.9% for third quarter

Fed policymakers – concerned the credit crunch and housing slump could take a heavy toll on economic growth – voted unanimously to cut interest rates by half a percentage point at their Sept. 18 meeting. Fed policymakers unanimously agreed to slash interest rates by one-half percentage point to 4.75 percent, calling it "the most prudent course of action," according to minutes of that meeting released yesterday (Tuesday).

The minutes also said that “given the unusual nature of the current financial shock, participants regarded the outlook for economic activity as characterized by particularly high uncertainty, with the risks to growth skewed to the downside.”

The release of the minutes of the policymaking Federal Open Market Committee (FOMC) buoyed hopes of another interest-rate reduction, and sent stock into record territory yesterday.

The Dow Jones Industrial Average soared 120.80 points, or 0.86%, to close at a  record 14,164.53 – eradicating the prior record close of 14,087.55 reached Oct. 1. The Dow set a new trading high, as well, reaching 14,166.97.

The Standard & Poor’s 500 Index rose 12.57 points, or 0.81%, to close at a record 1,565.15. It eclipsed the prior record close of 1,557.59, reached last Friday, and also achieved a new trading high of 1,565.26.

The Nasdaq Composite Index climbed 16.54 points, or 0.59%, to close at 2,803.91. This marks the first time the tech-laden Nasdaq has closed above 2,800 since January 2001.

A federal employment report back in September originally stated that the U.S. economy shed 4,000 jobs in August – the first such decline in four years. That sent stocks into a careening nosedive, based on fears the U.S. market was headed for a near-certain recession. But then, last week, revised figures showed that the economy actually added 89,000 jobs in August.

Job-creation continued to climb in September, when payrolls rose by 110,000 jobs.

That news eased fears the economy would slide into a recession and cast doubt on whether the Fed policymakers would cut rates again, at their next scheduled meeting, set for Oct. 30-31.
But back during the Sept. 18 FOMC meeting – without the benefit of the revised jobs figures – there was a tremendous concern that a weaker economy could worsen the credit crunch and, in turn, “reinforce the economic slowdown.”  While it was expected that the markets would stabilize over time, “participants judged that credit markets were likely to restrain economic growth in the period ahead,” the minutes went on to say.

If the Fed did not take action policymakers “saw risk that tightening credit conditions and an intensifying housing correction would lead to significant broader weakness,” not just in terms of economic growth but employment, as well.
 
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• Money Morning News Analysis:
  Surprisingly Dismal Jobs Report Unleashes Its Fury on the Federal Reserve and Wall St.

U.S. stocks posted moderate gains yesterday (Monday) – rebounding from early setbacks – as still-fretting investors get ready to navigate a stretch that will be largely bereft of corporate earnings reports or critical economic reports.

The Dow Jones Industrial Average climbed 42.27 points, or 0.32%, yesterday to close at 13,125.35, after experiencing gains and losses of more than 100 points each during the day. It was just below 13,000 at midday before shooting as high as 13,177.

The Nasdaq composite index posted a modest gain of 3.56 points, or 0.14%, to finish at 2,508.59. The Standard & Poor’s 500 Index skidded 0.39 points, or 0.03%, to close at an almost-even 1,445.

The markets reflected a lack of confidence despite the Fed’s move to cut the discount rate Friday. Plummeting U.S. Treasury yields, and layoffs by Countrywide and SunTrust Bank, had investors nervous early on.

But positive news came in the form of the Conference Board’s Index of Leading Economic Indicators, a closely watched gauge of future expansion. Its index of economic indicators showed a .4% increase in July an improvement over the .3% drop in June.

Of the Conference Board’s 10 leading economic indicators, consumer expectations, vendor performance, unemployment claims, real money supply, stock prices, and manufacturer’s orders for consumer goods and materials all showed improvement. Consumer confidence and jobless claims could increase in August, however.

The rest of this week will be light on economic reports, making it tough for investors to assess what the Fed might do at its next policymaking meeting. And with corporate earnings season mostly finished, there is little from that venue investors can use to make projections. The so-called “dog days of August” are some of the slowest stretches of the year for market researchers to make forecasts.

Markets in Asia also made notable rallies yesterday after taking some nasty hits on Friday. Tokyo’s Nikkei 225 Index climbed 3% after dropping 5.4% Friday. Hong Kong’s Seng Index made a 5.9% jump. And China’s Shanghai Composite 5.3% higher.

Sales of existing U.S. homes plunged nearly 11% in the second quarter as the nation’s real estate market continued its slump – just one in a slew of bad-news reports that emanated from the real estate market yesterday (Wednesday).

In related news:

• Countrywide Financial Corp. (NYSE: CFC) – the largest U.S. mortgage lender – saw its shares fall $3.17 each, or 12.96%, to close at $21.29, on rumors the mortgage company has been unable to raise money from the commercial paper market. Merrill Lynch & Co. raised the possibility of a forced bankruptcy, Bloomberg News reported.
• U.S. homebuilder confidence fell more than forecast to a 16-year low in August, according to the National Association of Home Builders/Wells Fargo Index of builder confidence, reaching lows not seen since 1991, when the U.S. economy was still suffering from recessionary fallout.
• U.S. stocks fell again yesterday after the Federal Reserve again added cash to the U.S. banking system, a move that will undoubtedly help in the long run, but in the short-term seemed to fan fears by reminding investors the credit crunch problems are still extant. The Dow Jones Industrial Average dropped nearly 170 points, closing below the psychologically important 13,000 level.

According to the National Association of Realtors, home prices dropped during the second quarter – the fourth consecutive quarter that they’ve done so – with the price of a typical single-family home reaching $223,800, a decline of 1.5% from the year-ago levels of $227,100. Not surprisingly, confidence among U.S. homebuilders also declined. 

The National Association of Home Builders/Wells Fargo index a gauge of industry-wide confidence, dropped two points to an overall score of 22.  The reading was the weakest since the index hit a record low of 20 during the 1991 recession.  A reading below 50 means most respondents consider conditions poor.  The gauge has consistently fallen over the past six months.

Hardest hit by the news may have been Merrill Lynch & Co. (NYSE: MER) and Countrywide Financial Corp. (NYSE: CFC), whose stock plummeted for the fifth-straight day after talk of bankruptcy surfaced. Its shares closed the day at $21.29, after declining nearly 13%. Merrill Lynch was down $2.40, or 3.3%.  Somehow, Thornburg Mortgage Inc. (NYSE:TSA) resurrected itself; gaining 38% after its shares lost nearly half their value Tuesday.

The Dow closed at a four month low of 12,861.47, after falling 167.45 points, or 1.29%. That closely watched blue-chip index has now shed nearly 1,000 points since topping 14,000 in July. Meanwhile, the S&P 500 turned negative for the year, closing down nearly 20 points, or 1.4%, to 1,406.70. The Nasdaq composite index dropped 40.29 points, or 1.6%, to reach 2,458.83.

The recently volatile Dow had also risen as many as 90 points Wednesday, as bargain-hunters sifted through pummeled shares. The volatility index of the Chicago Board Options Exchange hit yet another four-year peak.

"The most savvy investors are seeing an opportunity with the increase in volatility,” James Smothermon, active trading and investing strategist for discount broker Charles Schwab (Nasdaq: SCHW) , told The Associated Press. “Individuals not as used to this are having trouble navigating" the rough waters. He said that clients have been changing their strategies through tactics like buying insurance on their portfolios and buying put options, or they are employing contracts that let an investor sell part of an asset at a set price within a certain time period.

And while the central bank again added liquidity to the financial system, it has not shown any signs that it will cut interest rates at its Sept.18 policymakers meeting, the only substantive move that could ignited a stock market rally. But inflation fears have kept the Fed from making such a commitment, especially with energy prices still trading at high levels (albeit lower than peak prices); the Labor Department said yesterday (Wednesday) that its Consumer Price Index (CPI) rose a mild 0.1 percent in July, in line with what was expected, though noting, too, that energy prices remain high.

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