Banks, Fed to take stocks on rocky ride

NEW YORK (Reuters) - The rocky ride in U.S. stocks looks set to intensify next week with the survival of one of the biggest investment banks in doubt and regulators rapidly burning through options to limit more damage to the financial system.

All eyes will again be on Bear Stearns come Monday for any further word about the condition of the fifth-largest U.S. investment bank, which on Friday had to get emergency funding as fallout from the global credit crisis took its toll.

Bear Stearns is among four major Wall Street firms reporting earnings next week.

But the Federal Reserve's policy-setting meeting on Tuesday will be the focus of the holiday-shortened week. The U.S. stock market will be closed for Good Friday on March 21.

U.S. interest-rate futures on Friday showed more than a 50 percent chance that the central bank will cut its benchmark fed funds rate target by 100 basis points -- or 1 percent -- to revive an economy that many say is already in recession.

"Most of the focus will be on the Federal Reserve next week. Will the Fed cut rates? And if so, how much? And most importantly, what will the statement that accompanies the decision say?" said Hugh Johnson, chief investment officer of Johnson Illington Advisors in Albany, New York. "Frankly, the Fed said it all in their bailout of Bear Stearns."

Market participants have questioned the effectiveness of the U.S. central bank's efforts. On Tuesday, March 11, the Fed teamed up with other central banks to get up to $200 billion in fresh funds to cash-starved markets. The market rallied sharply for its best day in five years, but most of those gains were erased by the end of the week.

Then on Friday, Bear Stearns said a cash crunch forced it to turn to the Federal Reserve and JPMorgan Chase for emergency funds. That revived investors' fears about the depth and breadth of the credit crunch. Bear's stock tumbled as much as 50 percent on Friday to a session low at $28.42, its lowest since October 1998.

The 28-day emergency line of funding for Bear Stearns came just days after Bear, which has been hard hit by its heavy exposure to the faltering U.S. mortgage market, had dismissed market rumors of a cash crunch and said it was still a healthy player in the global web of trading and finance.

That heightened concerns that there may be other banks facing liquidity issues.

MOMENT OF TRUTH FOR BANKS

More clarity about the extent of write-downs could come when four big U.S. investment banks report earnings next week.

Bear Stearns is first out of the block on Monday, which also happens to be St. Patrick's Day. Bear moved up its earnings release, which was initially scheduled for Thursday. The change in schedule may indicate that Bear plans to make a significant disclosure, said Rebecca Engmann Darst, equity options analyst at Interactive Brokers Group.

"Speculation is rising that Bear Stearns could be the subject of a takeover or 'takeunder' over the weekend -- possibly with JPMorgan Chase," she added.

Lehman Brothers LEH.N and Goldman Sachs (GS.N) will report earnings on Tuesday, followed by Morgan Stanley (MS.N) on Wednesday.

On Friday, Lehman's stock was the second-biggest decliner among investment banks, falling 14.6 percent, or $6.73, to close at $39.26 on the New York Stock Exchange.

Forecasts and stock prices have come down sharply for all the big banks, as the credit crunch spreads across almost every market -- the contagion effect that Wall Street executives last year assured analysts was not happening.

S&P 500 FEELS BEAR'S BREATH

With Friday's slide, the S&P 500 was close to falling into a bear market. If it drops further next week, it could cross a threshold that normally indicates a bear market, which would be a drop of 20 percent off its October closing high. The Nasdaq turned bearish last month.

It was a wild week, starting with Monday's revelations that a federal probe showed New York Gov. Eliot Spitzer was "Client 9" who patronized a call girl working for a prostitution ring that charged rates of $1,000 an hour and up. That triggered a "schadenfreude festival" on Wall Street, where Spitzer had ferociously prosecuted wrongdoing during his years as New York attorney general. On Wednesday, the TVs on most trading desks were tuned in to watch live broadcasts of Spitzer's resignation as governor.

By Friday, the governor's scandal seemed like a faded memory when news broke about Bear Stearns' liquidity crisis. At the closing bell, the Dow Jones industrial average .DJI was down 194.65 points, or 1.60 percent, to end at 11,951.09, while the Standard & Poor's 500 index .SPX was down 27.34 points, or 2.08 percent, at 1,288.14, and the Nasdaq composite index .IXIC was down 51.12 points, or 2.26 percent, at 2,212.49.

For the week, the Dow Jones industrial average .DJI managed to finish with a gain of 0.48 percent, thanks to Tuesday's huge rally. But the Standard & Poor's 500 index .SPX slipped 0.40 percent for the week and the Nasdaq was unchanged -- right to the penny.

Since the end of February, the Dow has fallen 2.57 percent and the S&P 500 has dropped 3.19 percent, while the Nasdaq has declined 2.60 percent.

For the year so far, the Dow has lost 9.90 percent, the S&P 500 has dropped 12.27 percent and the Nasdaq has tumbled 16.58 percent.

RECESSION NOW?

Among the week's key economic data will be the U.S. Producer Price Index on Tuesday, which will get plenty of attention due to concerns about rising inflation even as the economy slows. Economists polled by Reuters expect February core PPI to rise 0.2 percent.

On Friday, a government report unexpectedly showed February's Consumer Price Index, another top inflation gauge, was unchanged. While that leaves more room for the Federal Reserve to cut interest rates, analysts were skeptical about the tame inflation picture painted by the data because prices of oil, gold and other commodities are at record highs.

Wall Street will get some other economic data next week that could give more clues about the U.S. economy's health, with industrial production and capacity utilization due Monday and February housing starts set for Tuesday.

Weekly jobless claims and the Federal Reserve Bank of Philadelphia survey of regional business activity for March will round out the economic week on Thursday.

For economists' forecasts on these and other economic indicators for the week starting March 17, please click on

<ECI/US>

As the numbers pour in, Wall Street will have one question on its mind, said Johnson of Johnson Illington Advisors.

"The question is: Did the economy enter a recession in February? We will get an answer to that question when we see the industrial production and housing numbers," he said.

(Additional reporting by Justin Grant and Doris Frankel; Editing by Jan Paschal)

(Wall St Week Ahead runs every Friday. Questions or comments on this column can be e-mailed to: kristina.cooke(at)reuters.com)