Fed Faces Credibility Crunch

What was startling surely to the Fed and to the markets was January's inflation reading. The Labor Department reported that core CPI rose 0.3% in January, ticking up to 2.7% year over year from 2.6% in December. Headline CPI rose 0.2%.

The stock market was disappointed with the data, as the Dow Jones Industrial Average and the S&P 500 took a breather from their weeklong winning streaks, both weighed down by the sell-the-news reaction reaction to Hewlett-Packard's (HPQ Quote) earnings report Tuesday evening.

The Nasdaq Composite bucked the trend, rising to a new high for the year, up 0.2% to close at 2518.42. The Dow Jones Transportation Average and the Russell 2000 also bucked the broad market trend, rising to new all-time highs. The DJIA fell 0.4% to close at 12,738.41, while the S&P 500 slipped 0.1% to close at 1457.63.

The transports rallied despite oil prices closing above $60 per barrel for the first time in 2007. More-than-1% gains in image-damaged JetBlue Airways(JBLU Quote), trucking outfits Con-Way(CNW Quote) and YRC Worldwide(YRCW Quote), and railroad Union Pacific(UNP Quote) led the transports' advance.

So even as the January minutes show the Fed is close to a neutral policy stance, the central bank is now perhaps just as close to a credibility crunch. That's if inflation were to tick up toward 3% year over year, says James Paulsen, chief investment strategist at Wells Capital Management.