ATLANTA (Reuters) -
The Federal Reserve must be "very
vigilant" amid strained financial markets while exercising
patience over interest rates as it waits for inflation to ease,
a top Fed policy-maker said on Wednesday.

"I am comfortable with the current policy. I believe we
need to give the second half (of 2008) a little time, to see if
the scenario that I personally am counting on plays out more or
less according to plan," Atlanta Federal Reserve President
Dennis Lockhart told reporters after a speech at an economics
conference hosted by Georgia State University.

In the speech, he said inflation was expected to moderate
from current uncomfortably high levels, thanks in part to
recent declines in the cost of oil. Still, he was cautious
about the outlook for the economy overall.

"Many markets continue to be strained ... It seems to me
that we have to continue to be very vigilant about the status
of the financial markets, and their potential negative impact
on the general economy," he told reporters.

This references a vicious downward spiral involving losses
related to U.S. real estate and tighter credit conditions as
banks curtail lending, which in turn makes it harder for people
to buy homes and aggravates mortgage losses further.

The Fed has slashed interest rates 3.25 percentage points
to 2 percent since mid-September to offset the situation. It
halted that rate cut campaign earlier this year and is now
expected to stay on hold until 2009.

Lockhart, a former banker who will be a voting member of
the U.S. central bank's interest rate-setting committee next
year, said that the fallout from the housing collapse and
credit crunch had not subsided.

"The banking system is experiencing a lot of strain and
some banks are in very difficult circumstances...we continue to
monitor banks in this particular part of the country and a
number of them are facing liquidity strains and asset quality
strains," he said

Economists think that worry about weakening economic growth
and fragile markets will keep Fed rates unchanged despite high
inflation amid soaring energy and fuel prices. Lockhart backed
this view, stressing that price pressures ought be temporary.

"With weak growth and financial market strains, I believe
the most likely outcome is that both headline and core
inflation will diminish over the rest of 2008 and into next
year as the temporary effects of energy and food price
increases abate," he said in the speech.

He also said inflation pressures would be helped by the
recent decline in oil prices and stabilization of the dollar.

"I think the stabilization of the dollar - which we hope
will hold - the stabilization has helped and ... the inter-play
between the dollar and commodity prices might also have an
influence on the dampening of those pressures," he told
reporters.

"The almost $30 drop (in oil prices) has certainly helped,
and we believe (it) will play through to the headline inflation
number in the second half (of 2008)," he said.

Lockhart stressed that inflation expectations, although
very important, had still not deteriorated badly despite
soaring costs for energy and food.

"If overall prices do not moderate in the near term as I
expect, inflation expectations could become unmoored," he
warned. "Inflation expectations may have risen modestly - but
not by a material degree."

But he said that keeping expectations under control was
crucial in navigating the U.S. economy through its current weak
patch, and he made plain he was ready to raise interest rates
if there was evidence they were becoming unstuck.

"Let me emphasize that I am mindful of today's elevated
risks and am prepared at any point to change tactics to ensure
inflation expectations do not become unanchored," he said.

(Reporting by Alister Bull; Editing by Chizu Nomiyama)

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WASHINGTON (Reuters) -
New orders for long-lasting U.S.
manufactured goods jumped a surprising 1.3 percent in July as
businesses ramped up spending plans and demand for a wide array
of items rose, a government report showed on Wednesday.

Strong demand for manufactured goods may ease some concerns
about sagging U.S. economic growth amid slowing consumer
spending and the long-slumping housing market. While strong
exports have buoyed the factory sector, analysts fear a
strengthening dollar and slowing economies overseas could
diminish that contribution in the future.

"The risk must be that in time the combination of slowing
global growth and a stronger dollar crimps exports, but for now
they are the lifeline," said Ian Shepherdson, an economist for
High Frequency Economics in Valhalla, New York.

Orders for durable goods, items meant to last three years
or more, were up after an upwardly revised 1.3 percent gain in
June, previously reported as up 0.8 percent, the Commerce
Department said. Analysts were expecting durable goods orders
to remain unchanged from the previous month.

U.S. Treasury debt prices fell as the report suggested
resilience despite the deep housing correction and credit
crunch. Major U.S. stock indexes were up about 0.5 percent,
mainly on the strong economic data, but the dollar slipped as
lingering doubts about the banking sector weighed.

Resilient manufacturing could strengthen the argument of
some Federal Reserve officials who have called for higher
interest rates to combat inflation. The Fed has held interest
rates steady at 2 percent since April despite persistently high
inflation as a consensus has prevailed that low rates are
necessary to counter soft labor markets and lingering financial
turmoil.

At the same time, some analysts worry the economy could hit
an air pocket in the second half of the year after being pushed
ahead at a reasonable clip in the second quarter by government
stimulus checks.

"Most of the increase in capital spending implied by these
data is being undertaken by companies benefiting from the
export boom; the domestic economy remains very weak indeed,"
Shepherdson said.

Transportation orders rose 3.1 percent in July, the largest
gain since February, on a 28 percent rise in civilian aircraft
orders.

Orders for machinery and primary and fabricated metals
rose, while demand for computers and appliances waned.

Even when volatile transportation orders were stripped out,
demand for durables rose 0.7 percent. Analysts had expected a
0.5 percent drop in durables orders excluding transportation.

Non-defense capital goods orders excluding aircraft, seen
as a barometer of business spending, jumped 2.6 percent, the
steepest gain since April. Analysts were expecting that
category to decline by 0.1 percent.

In a glimmer of hope for downtrodden housing markets,
mortgage applications rose for the first time in three weeks as
interest rates for 30-year fixed-rate mortgages, the most
common type of home loan, dipped to an average of 6.44 percent
from the previous week.

(Additional reporting by Walden Siew and Jule Haviv in New
York, Editing by Neil Stempleman)

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(Reuters) -
The New York attorney general's office is
probing the relationship between Fidelity Investments and
Goldman Sachs Group Inc. (GS.N) in connection with the sale of
auction-rate securities, the Wall Street Journal said, citing a
person familiar with the investigation.

Investigators are looking at whether Fidelity's
relationship with Goldman may have given the mutual fund giant
an incentive to sell the instruments, the paper said.

The attorney general started focusing on the relationship
after it learned that most of the auction-rate securities sold
by Fidelity were underwritten by Goldman.

These securities offered interest rates that reset
periodically in auctions, but when those auctions failed this
year, investors were stuck holding longer-term debt of
uncertain value. Dealers have been accused of understating the
debt's risk to investors.

Earlier this month, Merrill Lynch & Co Inc (MER.N),
Deutsche Bank (DBKGn.DE) and Goldman Sachs settled with U.S.
securities regulators, agreeing to buy back billions of dollars
of auction-rate securities.

The attorney general's office is probing whether Fidelity
may have marketed Goldman-underwritten ARS's because it was
getting other services from the investment bank, the paper
said.

Goldman Sachs was not immediately available for comments.

"There was no incentive for Fidelity to promote
auction-rate securities," the paper quoted Fidelity
spokesperson Anne Crowley as saying. She said 600 Fidelity
accounts held the auction-rate securities.

Goldman Sachs agreed to buy back about $1.5 billion in
auction-rate notes by November 12, and pay a $22.5 million
fine.

Goldman's agreement does not cover customers who bought
auction-rate securities from Fidelity. Massachusetts's top
regulator, William Galvin, has called on Fidelity to buy back
all the securities it sold.

Fidelity, which is privately held, has long said it neither
issues nor aggressively markets these securities and that it
expects underwriters who issued the securities to stand behind
them.

(Reporting by Saumyadeb Chakrabarty in Bangalore)

Source