Many private economists and Wall Street strategists believe the odds now favor an increase in interest rates when the Federal Reserve Board's policy-making committee meets later this month.
The Fed has said it is prepared to raise rates if the economy does not slow further and inflation picks up. Last fall it cut rates three times in quick succession amid a global financial crisis.
The market's sentiment can be read in the bond market, where rates on futures contracts pegged to the short-term rates set by the Fed now hover close to 5 percent. That is a quarter of a percentage point higher than the Fed's current overnight borrowing rate of 4.75 percent -- meaning the market expects the Fed to nudge rates upward by at least 0.25 points when it meets for two days beginning June 29.
"All eyes are on the Fed," said Stuart Hoffman, chief economist at PNC Bank Corp. in Pittsburgh. "We're all watching the data and how the Fed might react to that."
Rising interest rates could threaten the long-running bull market in stocks by making the safe return on bonds more competitive with stocks. Companies and consumers, meanwhile, would face higher borrowing costs, which could dampen consumer spending and crimp corporate profits.
The markets will focus today on the government's monthly report on unemployment, looking for signs that might influence the Fed. If the number of new jobs added to the economy in May was greater than the 215,000 that most economists anticipate, it could send jitters through the financial markets and push the yield on the 30-year Treasury bond above 6 percent for the first time since May 1998.
There has been a marked turnabout in the financial markets since April, with the release of a series of reports showing the economy continues to barrel along at a pace above the 2.5 percent to 3 percent growth rate the Fed is believed to view as sustainable without a rise in inflation.
The most damaging report so far, economists said, was the release last month of consumer price data for April, which showed a dramatic rise in inflation. Though that was discounted by many economists because of one-time spikes in energy, apparel and tobacco costs, the underlying "core" rate excluding those items still rose sharply. New York Federal Reserve Bank President William McDonough told reporters Tuesday that there was "a low chance" the April inflation number was a fluke, raising the importance of the consumer price index for May, which will be released June 16.
"One month is an aberration," said PNC's Hoffman. "Two months in a row begins to look like a trend."
Adding to the concern over higher rates was Tuesday's report from corporate purchasing managers that showed companies were seeing increased prices for the raw materials that go into the goods they make.
Even though some economists took comfort in other reports Tuesday that indicated some cooling off in the economy -- notably a 2.4 percent drop in construction spending in April -- they quickly became worried again when the Commerce Department reported that new-home sales in April rose an unexpected 9.2 percent from the previous month. Continued strength in housing and consumer spending are leading to a consensus view that the Fed needs to take a preemptive strike against inflation.
The yield on the benchmark 30-year Treasury bond, meanwhile, continues to edge close to 6 percent. In trading yesterday, the price of the bond fell 13/32, or $4.06 for each $1,000 in principal amount. Its yield, which moves inversely to the price, rose to 5.95 percent, from 5.94 percent on Wednesday.
"What markets do is they get to this panic stage," said William Lloyd, head strategist at Barclays Capital Group, a bond dealer in New York. "You need to relieve the uncertainty. Once the Fed meets, whether they raise rates or don't, that relieves some of the uncertainty."
Even if the Fed does raise rates by a quarter of a percentage point this month, the overnight lending rate would still be half a percentage point below its level before the cuts of last fall. And even if the yield on the 30-year bond reaches 6 percent, that would only bring it back to its level of May 1998, before the summer's financial crisis in Russia and other emerging markets.
Some economists say that a series of small rate cuts would prolong the economic expansion, now nearing a peacetime record, by pricking a speculative bubble in the stock market and nipping inflation in the bud.
With the world economy recovering somewhat, the Fed has the latitude to raise rates now to slow down the U.S. economy at a time when the crisis in Asia appears to have bottomed out, according to this reasoning.
"It's hard to make a case that taking back two or three of their easing moves would wreck the global economy," said Mark Vitner, economist with First Union Capital Markets Corp. in Charlotte.