MarketView for April 8

Summary 

The major stock indexes were the victims of a late sell-off on Friday as rising oil prices revived worries that inflation could derail the recovery, jolting a market that had been treading water ahead of corporate earnings.

The uncertain outcome of budget talks in Washington and the prospect of a government shutdown resulted in higher than normal volume in the purchase of short-term put options as a way to buy protection ahead of the weekend. Many traders bought short-term put options on the SPDR S&P 500 Trust.

The surge in oil prices drove down shares of airlines and transportation companies. The Dow Jones Transportation Average was down 1.7 percent. Brent crude futures settled above $126 a barrel, the highest level in 32 months, as the weak dollar drove up commodities and intense fighting in Libya raised fears of prolonged supply cuts.

Trading volumes remained low, a sign that investors are holding off major new bets ahead of the release of quarterly earnings beginning next week. Trading volume was 6.47 billion shares on the three major exchanges, compared with last year's estimated daily average of 8.47 billion.

The S&P faces resistance around 1,345, near its 2011 high. Many analysts believe earnings could be the catalyst that pushes the benchmark index through that resistance.

The earnings season will begin unofficially when Alcoa reports results after the market's close on Monday. JPMorgan Chase and Google are due to report later in the week.

Bullishness has risen to levels not seen since last December before earnings, according to a survey by Investors Intelligence. Bucking the downtrend on Friday, commodity-related shares rose with higher oil and metals prices. Occidental Petroleum rose 2.6 percent to $103.72.

Copper rose 2.5 percent while gold hit record highs on Friday and silver reached its strongest level since early 1980, as investors snapped up inflation-sensitive raw materials as a hedge.

The White House and Congress faced a midnight deadline to break a budget deadlock. Democratic and Republican leaders said there was still no overall deal on government funding for the rest of the fiscal year.

Fed Divide Continues

The major divide regarding the outlook for inflation and monetary policy as described by two top Federal Reserve officials on Friday underscored divisions at the central bank as it nears the end of a controversial stimulus program. In comments that reflect the majority view at the Fed -- including Chairman Ben Bernanke -- Atlanta Fed President Dennis Lockhart said it was unlikely that recent spikes in commodity costs will lead to runaway increases in prices.

"With longer-term inflation expectations remaining stable -- and predicting that commodity price growth will stabilize -- my view is that current monetary policy is appropriate," Lockhart said.

Richard Fisher, president of the Dallas Fed and a self-proclaimed inflation hawk, took a divergent view, saying that prolonged easy monetary policy could compound what might otherwise be transitory inflationary pressures.

Warning of "unpleasant" inflation data ahead, Fisher called on the Fed to stop "spiking the punch bowl" with more accommodative policy and said the Fed may even need to end its $600 billion bond-buying program early.

"No amount of further accommodation by the Fed would be wise," he told the Society of American Business Editors and Writers in Dallas. "Indeed, it may well be that we should consider curtailing what remains of QE2," he said, referring to the Fed's second round of quantitative easing, which is slated to end in June.

The prices of oil and other commodities have spiked, sparking inflation fears, hit by both strong demand from rapidly growing emerging economies and fears of supply disruptions amid a wave of pro-democracy protests in the Middle East and North Africa. Crude has been trading at the highest prices since September 2008, rising above $110 a barrel, and the average price of gasoline stands around $3.70 a gallon.

Lockhart said that while costly fuel is putting a dent in household budgets, the overall effect on inflation is likely to be muted. In part that's because high unemployment -- at 8.8 percent in March -- is keeping wage-driven inflation under wraps, he said.

Conceding that point as "reasonable," Fisher -- who holds a voting seat this year on the Fed's policy-setting panel -- nevertheless said the Fed should not compound the risk of fueling inflation by adding more liquidity.

Several other hawkish Fed policy makers have pushed noisily in recent weeks for the central bank to heed signs of incipient inflation and to begin to think about raising rates, as the European Central Bank did on Thursday for the first time since 2008.

But Bernanke and other core members of the Fed's policy-setting Federal Open Market Committee have said the recovery is too fragile to withdraw support yet.

Given the still-fragile nature of the recovery, Lockhart said Fed officials should avoid discussing their exit strategy in too great detail, lest they send the wrong signal to the public and financial markets about the direction of interest rates.

In response to the deepest recession in generations, the Fed slashed interest rates to near zero and also committed to buy more than $2 trillion in government bonds and mortgage debt.