U.S. investors will watch next week to see if the latest employment numbers temper inflation expectations, without sharply dimming the outlook for corporate profit growth, giving stocks a chance to bounce back from May's sharp sell-off.

For stocks to rally, analysts say the economy needs to slow enough to calm the Federal Reserve's worries about inflation so that policy makers can end their two-year campaign of hiking interest rates. Friday's job data showed hiring dropped last month, but it may have been by too much for Wall Street's liking.

This may be an indication the Fed will have to pause at its next meeting, which in the short term, could be very supportive to stocks, said Michael Metz, chief investment strategist at Oppenheimer Holdings Inc. in New York.

But if the economy is beginning to slow down, if the dollar keeps falling and commodity prices remain high, we will need a massive inflow of capital, and then again, it will be hard to do it without raising interest rates, Metz said.

With only two major economic indicators on tap next week, market players will have plenty of time to consider the implications of the jobs report. On Monday, Wall Street will watch for the ISM's report on the U.S. services sector. On Friday, the U.S. trade deficit data will merit attention.

Traders will take the weekend off to digest what the weak jobs data means for stocks and what industries will be most impacted by slower-than-expected growth in employment, said Fred Dickson, market strategist at D.A. Davidson & Co. in Lake Oswego, Oregon. Those would probably be cyclical industries.


On Friday, the Labor Department said U.S. employers added only 75,000 jobs -- or 100,000 short of what economists had forecast. Average hourly earnings, a measure of wage inflation, went up just 1 cent -- less than Wall Street expected.

Phil Orlando, chief portfolio manager at Federated Investors in New York, said, This data is exactly what we've been looking for: a suggestion that the economy is slowing and inflation is coming off the boil. That would suggest the Fed is close to the end. We think there will be one more hike in June and that's it.

The Federal Open Market Committee's next meeting is set for June 28-29.

Wall Street's view of the chances of a June rate increase sank to as low as 42 percent after the jobs data from 68 percent before the report, according to interest-rate futures.

In May, the Fed raised rates for the 16th consecutive time since June 2004. That brought the federal funds rate for overnight bank loans up to 5 percent -- up sharply from its historic low of 1 percent two years ago.

Investors will listen closely for any clues about the Fed's intentions when Chairman Ben Bernanke take part in a panel discussion with his European Union counterpart, Jean-Claude Trichet, and Bank of Japan Deputy Governor Toshiro Muto in Washington on Monday.

On Friday, the Dow Jones industrial average slipped 12.41 points, or 0.11 percent, to end at 11,247.87. The Standard & Poor's 500 Index rose 2.51 points, or 0.20 percent, to finish at 1,288.22. The Nasdaq Composite Index dipped 0.45 of a point, or 0.02 percent, to 2,219.41.

For the week, the Dow fell 0.3 percent, while the S&P 500 gained 0.6 percent and the Nasdaq added 0.4 percent.


In the week ahead, two economic reports will serve as bookends. On Monday, Institute for Supply Management will release its widely followed index of the non-manufacturing, or services, sector of the economy.

The services sector, which makes up about 80 percent of U.S. economic activity, is likely to have slowed in May. The median forecast is for a May reading of 60, down from 63 in April, according to a Reuters poll of 72 economists. The services sector includes businesses like restaurants, hotels, hair salons, banks and airlines.

On Friday, the Commerce Department will release the April data on the U.S. international trade deficit. The forecast calls for the trade gap to have widened to $65 billion in April from $62 billion in March, according to the Reuters poll.


The earnings calendar of S&P 500 companies is light next week, with only BMC Software Inc., H&R Block Inc. and National Semiconductor Corp. slated to report results next week.

Still, the week may not lack market-moving headlines with the start of Corporate America's so-called confession period, when companies reveal whether they will miss or exceed their quarterly forecasts.

On Friday, the No. 2 U.S. home builder, Pulte Homes Inc., cut its profit outlook for the rest of the year as rising interest rates slow the U.S. housing market.

The fact is that slowing in the economy is going to be consumer-oriented. Look at Pulte's downward guidance, Orlando said. Industrial capital spending is still strong and will remain strong. We would continue to edge away from consumer sectors and more toward corporate enterprise.

(Wall St Week Ahead runs weekly. Questions or comments on this column can be e-mailed to: jennifer.coogan(at)reuters.com)