Coming Week: Don't Count on the Fed

Stocks will limp into the next week at levels not seen since the Bear Stearns debacle, with no hope of a boost from the Federal Reserve.

Oil and other commodity prices rallied again last week while credit conditions worsened on Wall Street and the dollar weakened further.

The Fed, which will release its June decision on interest rates Wednesday, will almost certainly hold steady, leaving investors to parse through its policy statements for any sign of what will come next.

"Our view is that the pressures on the Fed are going to get worse over the next few months," says Lehman Brothers economist Ethan Harris. "They're going to face headline inflation of about 5% with the release of the August CPI, but simultaneously, they'll see a continued string of weak labor market reports with a rising unemployment rate, so those two pieces of data are going to offset each other and leave the Fed with its hands tied."

Crude oil futures bubbled up again Friday to close near $135 a barrel while stocks tanked. The Dow Jones Industrial Average lost 3.8% over the week and fell back below the 12,000 mark to finish up at its lowest close since March 10. The S&P 500 shed 3% to hits its lowest close since March 28, and the Nasdaq Composite dropped 2%.

The latest spike in crude came after The New York Times reported Friday that Israel has performed a military exercise in potential preparation for a bombing of Iran's nuclear facilities. The market's reaction was a stark demonstration of the sensitivities that exist on Wall Street to geopolitical shocks as it grapples with a relentless financial crisis.

Against that backdrop, Saudi Arabia was to host an oil conference over the weekend aimed at calming jitters in global markets about fossil fuel supplies. RGE Monitor analyst Rachel Ziemba says the Saudis want to show investors that they're concerned about the toll that high oil prices are taking on the global economy.

"We may start to see some market actors begin to acknowledge that oil is at its peak and may start trending downward," says Ziemba. "Rising global demand for commodities underpins the bull markets in commodities, but oil and other markets have gone too far. At some point, there will be a more sustained pullback."

Ziemba notes the Saudis already have added a half-million barrels a day to global supplies in recent weeks, and they may add more. Meanwhile, demand for gasoline in the U.S. and Europe is waning as consumers adjust to higher prices; China is lowering its gasoline subsidies. Also, she says the Fed has played a role in pushing oil prices higher.

"The aggressive easing that we've seen from the Fed and injection of liquidity has found its way into the energy markets," says Ziemba.

Meanwhile, in the U.S. stock market, financials are getting pounded as investors factored in a fresh round of writedowns on mortgage-related securities. Lehman BrothersLEH dropped 8% last week amid lingering questions about its ability to survive the credit crunch in the wake of Bear Stearns' collapse. Citigroup C shed 5%, Morgan StanleyMS lost 8% and Merrill Lynch MER was down 6%.

Merrill has been singled out for its counterparty risk exposure to bond insurance giants MBIA MBI and Ambac ABK, which were both downgraded as expected last week by Moody's. Without triple-A credit ratings from the major ratings agencies, the bond insurers don't have a business model, and their shareholders could be stripped by insurance regulators to protect policy holders. Shares of MBIA lost 9% last week, while Ambac dropped 8%.

Meanwhile, credit downgrades for the bond insurers were accompanied by a rash of downgrades for the securities they guaranteed, reflecting a broad deterioration of credit conditions in the bond markets. At the same time, Moody's and Standard & Poor's signaled likely credit downgrades for major U.S. automakers General Motors GM, Ford F and Chrysler, reflecting a cultural shift toward fuel efficiency in the U.S. and the "dire state" of the auto-financing market.

Ford announced that it's delaying the release of its new F-150 pickup truck amid production cutbacks, and it sees sales weakening into 2009. Its shares lost 8% last week, while GM shares were down 16% to their lowest levels since 1982.

The market action paints a dark picture for the U.S. economy, and the outlook, as it weighs on American consumers, is likely to show up in the Conference Board's release of its consumer confidence index in June. Economists expect it to slip to 57 from 57.2 -- its lowest reading in 16 years.

The Fed will announce its decision not to change its short-term interest rate target on Wednesday afternoon, and beforehand, the government is expected to report before the opening bell that orders for durable goods were flat in May after dipping 0.5% in April. Later, investors will receive May's tally of new-home sales from the Commerce Department, and they'll also see a report on crude oil inventory levels, which could roil the energy markets.

Wednesday is also a big earnings day, with reports expected from Monsanto MON, Nike NKE and Research In Motion RIMM.

On Thursday, investors will be greeted with the government's final report on first-quarter GDP growth, which was previously estimated to be 0.9%. That figure is expected to stay positive at around 1%, although there's still a crowd out there that believes a recession began early this year when job growth turned negative and will ultimately show up in the numbers.

Later, the National Association of Realtors will report its existing-home sales tally for May, and most economists expect to see further deterioration in the housing market.

Friday will see earnings from KB Home KBH, and the government is expected to report that personal incomes rose 0.4% in May, up from 0.2% in April, while personal spending was up 0.7%, up from 0.2%. The PCE core inflation rate for May is expected at 0.2%, which would give the Fed more support to argue that inflation is contained and rates should be left where they are.

Despite all the economy's problems, Frank O'Connor of Zecco Trading is still holding out hope.

"We'll avert recession, but barely," says O'Connor. "This is all part of a bottoming-out process."