Looking beyond the headline...

Although at first blush, the retail sales report looks ugly, but it turns out that the entire decline is due to lower gas prices. This supports a theory many economic bulls have been touting -- lower gas prices will offset any effect housing prices have on consumer spending. Some of the areas of increased spending are particularly encouraging: eating out +1.0%, furniture +0.2%, electronics +0.2%. These are things consumers wouldn't be buying if their economic situation were dire.

The 10-year has given up 2 points in price and 25bps in yield since 9/25.

The data is becoming less and less supportive of any sort of Fed cut in 2007. Virtually every FOMC member that has spoken in the last 2 weeks has included the following point in their speech:

1) Inflation is above their comfort zone.
2) Impending economic weakness (due in large part to the housing market) will push inflation lower without the need for further rate hikes.

However, if we keep seeing strong retail sales numbers, point #2 is no longer valid. If you don't see weak housing turning into weak consumer spending, then you can't expect it to have any impact on inflation.

I think this brings the possibility of the next move being a hike back into play. Maybe its only a 10% chance. But let's say there is a 10% chance of a hike in March, and 50% chance of no move. You need to expect a 40% chance of 5 rate cuts starting in March to justify where the 2-year is now. The set of information we have available to us doesn't suggest the odds of such an aggressive Fed are 40%.