The stock market is rallying because investors think the Fed will not raise rates on September 20th. Even if the Fed pauses, I believe it will only be temporary. That being said, let's look at how investors might view a Fed pause.
1) If the Fed does pause its because they think the economy is weak and a recession is right around the corner- Market Sells Off.
2) If the Fed doesn't pause, it believe's that the effects from Katrina will not have a long-term economic effect on the economy- Market Sells Off.
3) Finally, the Fed has to continue raising rates to protect the dollar due to the massive federal debt, and feels they have no choice but to stay the course to prevent foreign investors from selling their US debt holdings.
Is the current rally the beginning of a new bull market ? Not in my opinion.
At this stage of the game. I would look for the Fed to raise rates another quarter point this month. The market will take this news as a dissapointment, and likely sell off.
The Katrina oil shock was already a problem before the storm. Katrina only made it worse. Our biggest problem was not a supply of oil, but the refined product. The only way to cure an Exogenous Shock such as oil is to reduce demand. History shows that oil shocks are only curtailed through recessions.
I would expect that $3.00 gasoline prices is causing a lot of consumers to change their spending patterns. Many are talking about the falling price of oil, but the spread between a barrel of oil and the price of gasoline is resulting in huge profits for the oil companies.
The current rally could be the last, or next to the last one for the markets, especially if 4th quarter spending starts off slow. All eyes on Wall Street will be on the economy for 2006.
