Consumer prices begin on high note
The consumer price index jumped 0.6 percent in January after gaining only 0.2 percent in each of the two previous months. Energy prices surged 3.9 percent during the month after several months of much smaller gains. In contrast to previous months, where the energy spurt was mostly concentrated in gasoline pump prices, this month's gain was in home heating fuel and piped gas and electricity. This put the total yearly rise at 3.7 percent, up from last month's 3.4 percent gain.

Excluding food and energy prices, the CPI rose 0.3 percent in January, higher than the previous month, but in line with the November rise. Some special factors did contribute to the rise. For instance, tobacco product prices jumped 1.9 percent in January, reversing half of the previous month's loss. This component is highly volatile from one month to the next. New and used car prices accelerated a bit, although not as much as in the PPI where the end of manufacturer rebates had a bigger impact. In addition, medical care costs jumped 0.6 percent in January, twice as fast as the average of the past couple of months. On a year-over-year basis, the core CPI rose 2.6 percent, up only a tick from the previous month.

Is inflation a problem that should worry Fed officials? Should it take priority over the pace of economic activity in their policy deliberations? Clearly, inflation trends did turn around in 1999. The chart above shows yearly inflation rates for services and commodities. Commodities include energy prices, so the sharp upward momentum from 1998 through 2000 mainly is due to rising oil prices. Similarly, the downward trend since the peak last year reflects some downshift in gasoline prices. But more importantly for the Fed, is the service sector - which accounts for more than half of the consumer price index. The rising trend in the service category of the CPI could be reflecting the higher wages that we have seen in the past few years. To some extent, the CPI is a lagging indicator of activity, so that the softer pace of economic growth, with perhaps a rising unemployment rate, could take the bite off future wage hikes. In turn, that should lead to slower growth in service prices as measured by the CPI.

So what does this mean for Fed policymaking? Yes, the Fed is always concerned with inflation - but the January spurt was mainly due to special factors. At this point, slower economic growth is likely more important to the Fed than one month's inflation scare. Indeed, San Francisco Federal Reserve President Bob Parry and Atlanta President Jack Guynn said as much after the CPI release. If economic indicators continue to point to weak economic growth, the Fed is most likely to ease credit conditions further by lowering interest rates. It may mean that the rate reductions are smaller and slower if they believe inflation is truly a problem. At this point, it is too soon to tell. The Fed will have February PPI figures before the next FOMC meeting on March 20.

International trade is a drag
The international trade deficit on goods and services remained nearly unchanged in December at $33 billion. On average, the monthly trade deficit was larger in the fourth quarter of last year than the third quarter. This acts as a drag on fourth quarter growth. While the monthly deficit wasn't all that different during the month, growth in both imports and exports declined again. On a year-over-year basis, imports and exports have been posting smaller and smaller gains. The drop in imports reflects the slowdown in demand for goods and services in the United States as a whole. Import demand typically declines with the economy. The weakness in exports stems from lack of robust expansions across the globe. Foreigners are not purchasing U.S. exports as much as they were several months ago.

Treasury surplus expands
The U.S. Treasury announced a budget surplus of $76.4 billion for the month of January. This was more than twice as large as the December surplus and up from a year ago as well. As a result, the year-to-date surplus stands at just under $75 billion for the current fiscal year compared with a $41.5 billion surplus for the same period last year. As long as the surplus continues to increase, it will mean that Treasury borrowing will decline. The U.S. Treasury has already announced the elimination of the 52-week bill (next week will be the final auction for this security) and is considering the elimination of the 30-year bond as well.