Bulls crave more calm as Fed in focus

By Ellis Mnyandu

NEW YORK (Reuters) - Wall Street is heading for another volatile week, but the bulls could get a further reprieve if calm brought on by the Federal Reserve's liquidity injections and a surprise cut in its discount rate lasts.

The coming week has a slew of economic indicators, including July existing home sales and preliminary figures on second-quarter gross domestic product, which should shed more light on the economy's health.

But paramount to Wall Street will be what the data says about the prospects for a cut in the fed funds rate as the housing slump fuels worries that the sector's slowdown could tip the world's largest economy into a recession.

"Wall Street is banking on a mid-cycle slowdown that was expected but could get worse, suggesting that the Fed may want to lower the fed funds rate," said Rob Goodman, director of investments for Fairport Asset Management, in Cleveland.

"A cut," he said, "is not out of the realm of possibilities ... and I don't expect Wall Street to be too negative going forward."

But even with the burgeoning calm, money managers and analysts say a sense that there could yet be more upheaval due to weakness in the housing industry still pervades the market and could make for cautious trading ahead of the Labor Day holiday on Monday, September 3.

Volume is likely to be lighter than normal with many of Wall Street's denizens on vacation or cutting the week short for the last long weekend of summer.

Lots of economic numbers and exceptionally light volume often is a recipe for volatility. The Chicago Board Options Exchange Volatility Index .VIX, also known as Wall Street's fear gauge, ended Friday at 20.72, down 8.4 percent. The VIX is down almost 45 percent from August 16, when it climbed to 37.50, a five-year high.

HIGH HOPES FOR A RATE CUT

More worrisome, analysts and money managers said would be any news that pointed to further turmoil in the subprime mortgage sector.

This past week several mortgage providers, including Accredited Home Lenders Holding Co LEND.O, said they were cutting hundreds of jobs as the lending squeeze and lingering jitters in the credit markets take their toll.

Still, the clamor for a cut in the fed funds rate is providing a cushion for stocks as shown by Friday's stock market advance. Surprisingly strong data on July new home sales and durable goods orders contributed to the market's calmer tone.

Friday's gains sent the Dow Jones industrial average .DJI up 2.3 percent for the week, its best weekly advance since April 22. Both the Nasdaq Composite Index .IXIC and the S&P 500 .SPX notched their biggest weekly gains in five months, with the Nasdaq rising 2.9 percent and the S&P gaining 2.3 percent.

Before the latest turmoil, data showing the economy's pace of growth was stronger than expected would have rattled investors, quashing the oft-repeated view of a "Goldilocks" scenario -- an economy that's neither too hot nor too cold.

But with investors still uncertain about the extent of the impact of the faltering housing market and losses from subprime mortgages, Wall Street is set to latch on to any news showing that the economy is weathering the real estate downturn, albeit with bumps along the way.