Russell continues descent as market dishes up news for the bears

Small caps pulled off their lows midday though remained besieged in the red after a government issued consumer spending report showed a sizeable jump in inflation and after Europe’s largest bank HSBC reported a dismal quarter, warning for continued challenges near term. Traders were also treading carefully ahead of the Federal Reserve’s Federal Open Market Committee meeting Tuesday.

At 12:30 p.m. ET, the Russell 2000 (NYSE:IWM) was down 8.87, or 1.24% at 707.29, while the Dow has managed to eclipse the green, up 4.89, or 0.04%, to 11,331.21.

This morning’s personal income report from the Commerce Department highlighted the threat of inflation. While personal income clocked in better than expected at an increase of 0.1% compared with the forecast of a decline of 0.2%, the inflation portion of the report showed the year-over-year PCE price index soared to 4.1%-- the highest rate in 17 years. The rise in personal income was the smallest rise since April 2007 and was owed mostly to the increase in gas prices.

Investors have become increasingly skittish about the threat of inflation, as rising energy prices have served to crimp consumer purse strings and this report served to play to that fear.

With the limelight on the personal income report, investors paid little attention to the better-than-expected factory orders report, which came in at 1.7%, above the consensus forecast for a rise of 0.7%.

The Federal Reserve holds its monthly policy meeting Tuesday and is widely expected to hold the Fed Funds target steady at 2%. Investors will focus on the central bank’s comments in light of anemic second-quarter GDP data and continued inflation fears.

“With personal spending higher than expected in June and a likely upward revision to inventories, U.S. GDP for Q2 is likely to be revised north of 2%,” Andy Busch, global foreign exchange strategist for BMO Capital Markets said in an email. “This will make it very difficult to get the wheels rolling on the ‘recession procession’ of market participants clamoring for a Fed rate cut.”

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