Inflation report looms after markets again choke on oil, Fed

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Wall Street woke up this morning determined to have a nice day. But by the closing bell, the drugs had worn off.

You can thank the usual buzz killers: oil and the Federal Reserve.

The next test for rickety markets comes on Friday with the government’s report on May consumer price inflation.

Today, the Dow industrials were up as much as 186 points early on, nearly recouping Wednesday’s drop, after the government said retail sales rose 1% last month, the biggest jump since November. That was a clear sign that many consumers were spending their tax rebate checks, just as the Bush administration had hoped.

What’s more, a $46-billion takeover bid for Anheuser-Busch Cos. by Belgium’s InBev left the impression that foreigners, at least, may believe that U.S. stocks are cheap.

And even oil cooperated, for a while, with near-term futures falling as much as $4.83 a barrel, to $131.55.

But there seems to be no way to keep the oil bulls down for long these days. The price rebounded by the end of trading, closing up 36 cents at $136.74 a barrel -- even in the face of a stronger dollar, which usually pulls commodity prices lower. As oil recovered stocks sank. The Dow closed at 12,141.58, up 57.81 points, or 0.5%; broader indexes were weaker.

Wall Street also was spooked by the latest Fed missile launched in the war of words on inflation. Charles Plosser, president of the Fed’s Philadelphia bank, said on CNBC that the central bank must ‘act preemptively’ to damp inflation pressures. That added to the growing belief that the Fed will begin boosting short-term interest rates by fall. (And if the consumer keeps spending, that gives the Fed more cover to make a move.)

‘It looks like they do want to start raising rates,’ said Ray Remy, head of fixed income at Daiwa Securities in New York.

Plosser’s comments helped spark another big sell-off in Treasury bonds that pushed the yield on the two-year T-note to 3.04%, the highest since Dec. 31. (How much have investors’ rate expectations changed in the last week? Just last Friday they were willing to buy two-year T-notes at a yield of 2.38%. D’oh!)

The Fed’s new inflation paranoia places more than the usual importance on the May consumer prices report due Friday. Most analysts figure prices were up 0.5%.

But Ian Shepherdson of High Frequency Economics warned in a report today that ‘the unpredictability of food, home heating oil and utility prices means a slightly bigger increase is also possible.’

Get the drugs ready.