Stocks Fall Despite Oil-Price Drop

Inflation fears diminished as energy and other commodity prices dropped, but trading was quiet ahead of Tuesday's Fed announcement

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Major U.S. stock indexes finished lower Monday after a recovery attempt late in the day sparked by falling oil prices evaporated. But the plunge in oil prices on abating hurricane concerns and general weakness across the commodities complex did help diffuse some of the market pessimism caused by a rise in inflation.

Natural gas, platinum and copper prices all fell to six-month lows, while corn traded at its lowest levels in four months.

On Monday, the Dow Jones industrial average closed 42.17 points, or 0.37%, lower at 11,284.15. The broader S&P 500 ended down 11.30 points, or 0.90%, at 1,249.01. The tech-heavy Nasdaq composite index gave back 25.40 points, or 1.10%, to finish at 2,285.56.

On the New York Stock Exchange, 21 stocks were trading lower for every 10 that were gaining, while on the Nasdaq the ratio was 19-9 negative amid slow trading pre-Fed announcement. Energy and basic materials stocks were down, as were financials, but consumer staples and discretionary names were trading higher, S&P MarketScope said.

The market was initially spooked by a jump in an inflation gauge contained in the government’s personal income report for June, though those fears eased somewhat with the drop in commodity prices. The personal consumption expenditure (PCE) deflator surged 0.8% on the month and is up a hefty 4.1% over last year, well above the upwardly revised 3.5% year-over-year gain in May (from a 3.1% rise before). The core PCE deflator rose 0.3% in June and is up 2.3% from last June -- and above the 2.2% y/y pace seen since March.

The headline figure on the personal income report came in at a better than expected rise of 0.1% in June, beating expectations of a 0.3% decline due to adjustments in tax rebate assumptions in the revised data, Action Economics said. Income would have increased 0.3% in June and an estimated 0.3% in July, were it not for rebate distortions. Disposable income dropped 1.9% in June following a hefty 5.7% spike in May.

While the income and spending readings were a bit better than expected, thanks to the tax rebate checks, the big jump in inflation have worried markets ahead of the FOMC meeting, says S&P senior economist Beth Ann Bovino.

All eyes are on what the Federal Reserve policy committee's next move will be in steering the economy. The committee heads into its Aug. 5 meeting sharply divided over the appropriate direction of policy, with three of its 10 voting members having expressed their concern in recent weeks over future inflation. Economists are betting the majority, led by Chairman Ben Bernanke, will prevail in holding the Fed’s target rate steady at 2%.

Despite the higher inflation deflator figure, recent events auguring more tough times for the economy have diminished the inflation hawks' argument for a rate hike and might even put the possibility of a rate cut back on the table at some point during the second half of 2008. The troubles at the mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) have pushed up mortgage rates and created tighter credit conditions generally, whiles slower growth abroad, especially in Europe, will slow U.S. exports. Cheaper oil, if sustained, will also weaken concerns about a broader rise in inflation.

"The economy is too unstable for them to raise rates any time soon," says Doug Roberts, chief investment strategist for ChannelCapitalResearch.com, based in Shrewsbury, N.J. "We have the credit crisis, the housing crisis shows no signs of a bottom, and demand for oil, which is source of inflation, is a global thing [based on] demand driven by emerging markets."

Raising interest rates would hurt the U.S. economy more than it would the world economy, which is where a more pronounced slowdown is needed to rein in long-term trends in oil consumption, he says. Lately, oil prices have been cooperating, giving the Fed cover to hark back to its prior position on core inflation moderating over time, he adds.

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