Wall Street indexes are flirting with record highs on the heels of a hefty Federal Reserve rate cut, but the market faces headwinds with data in the coming week likely to show a struggling economy.
The powerful rally in the past week showed equity investors cheering the Fed's half-point rate cut even though, some analysts say the move highlights an economy dangerously close to recession.
In the week to Friday, the Dow Jones Industrial Average jumped 2.8 percent to 13,820.19, within striking distance of its all-time high of 14,000 hit on July 19.
The broad market Standard & Poor's 500 index advanced 2.8 percent as well to 1,525.75, near its record of 1,553.08. The tech-heavy Nasdaq rose 2.65 percent on the week to 2,671.22.
The best rally in four years on Wall Street was sparked by Tuesday's move by the Fed to cut key the federal funds rate by half a point to 4.75 percent, easing borrowing conditions for a large number of consumers and businesses.
Many investors said the action provides insurance against a deep economic downturn, although some said the move poses the risk of fuelling higher inflation and bailing out speculators.
The question for many now is whether the world's biggest economy will remain on an expansion track, or if the Fed cut signals trouble ahead.
"In our view, the twin shocks of a deeper-than-expected US housing recession and the associated freezing up of large parts of the credit market machinery threaten a downturn in the US and spill-over to the rest of the global economy," said Paul Sheard at Lehman Brothers. "However, we also judge that appropriate action - some, like the Fed's, largely anticipatory - will help to avert a serious downturn."
Goldman Sachs' economist Ed McKelvey said he has further downgraded his outlook for the US economy. "Specifically, we now expect real (economic) growth to drop into the 1.0 to 1.5 percent range from the fourth quarter of this year through the first half of next year, after which we expect modest improvement, to a 2.0 to 2.5 percent range," he said.
Despite the Fed action, McKelvey said, "the full effects of today's and any subsequent easing will not be felt until sometime in the middle of next year."
Fred Dickson, chief market strategist at DA Davidson, said that some caution is still advisable.
"Investors seem to be stepping back to reassess the overall economic landscape including the potential for higher inflation following the Fed action on Tuesday," Dickson said.
"In the aftermath, the dollar is getting hit hard and gold prices are surging. Predictably, longer duration bond yields are moving up sharply, which is not a good thing for the current mortgage refinance marketplace. We continue to expect a choppy market through the end of the current quarter and into October as hedge funds act to meet cash redemptions through sales of their most liquid holdings, which most likely are stocks and bonds." In the coming week, the market will take a cue from reports on new and existing home sales, as well as consumer confidence.
"Indicators next week will continue to highlight the downside risks associated with the housing sector," said economists Brian Bethune and Nigel Gault of Global Insight, in a note to clients.
But they said they expect a "September uptick in consumer sentiment" that could suggest a "slow-to-moderate" expansion for the economy despite the housing slump.
Bonds fell over the past week amid a move into equities and on concerns that the rate cut may lead to higher inflation. The yield on the 10-year Treasury bond jumped to 4.632 percent from 4.462 percent a week earlier, and that on the 30-year Treasury rose to 4.891 percent from 4.724 percent. Bond prices and yields move in opposite directions.
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