We’ve had another week of almost manic ups and downs in the markets as investors digest both good news and bad on the economic front as well as from companies. Despite the downward trend this week, we had a spectacular late afternoon rally after CNBC reported that a bailout for Ambac should be announced next week.

Both the S&P 500 and the Dow Jones Industrial Average both finished up with gains of 0.2 percent and 0.3 percent, respectively. And the Nasdaq Composite trimmed its losses to finish down 0.8 percent for the week.

The National Association of Home Builders (NAHB) index posted its second straight month of improving sentiment about builders with the index rising to 20, but any reading below 50 indicates a negative outlook for the industry. Based on responses to the questionnaire the NAHB uses to compile its index, the organization believes that the growing volume of prospective buyers touring homes is what buoyed the index.

But that hasn’t translated into action yet, with the pace of new housing starts up a meager 0.8 percent in January and the number of permit applications down 3 percent for the same period. The drop in permit applications points to a further slowdown in construction in coming months because builders are hesitant to start new construction in the face of a supply glut and tight lending standards.

Applications for new mortgages and refinancings plummeted this week, with the Mortgage Bankers Association’s weekly activity survey posting a 22.6 percent drop. That drop off in activity has been largely blamed on increasing mortgage rates, with the average rate for a 30-year fixed-rate mortgage rising to 6.09 percent versus the 5.72 percent. One interesting point in the association’s data is that the application activity for adjustable-rate mortgages actually increased to 12.8 percent from 9.9 percent the previous week, given all the negative press the products have received over the past few months.

This week’s inflation numbers were also bad news for home builders–and all Americans in general–with the Consumer Price Index (CPI) posting another 0.4 percent monthly increase. The worst of the price increases came from food and energy, which both posted 0.7 percent gains over December. So the core Federal Open Market Committee-monitored CPI, which excludes food and energy costs, posted a 0.3 percent monthly gain. Although that’s not as large of a jump, it still puts inflation at the limits of the Fed’s comfort zone.

That ties the Fed’s hands as far as the size of future rate cuts. And it also means we’ll probably see rate increases as soon as the US economy appears to be out of the woods.

The country’s employment situation isn’t improving, despite the number of initial jobless claims falling this week to 349,000. The major concern is that the pace of hiring has slowed to a crawl, with ongoing unemployment claims continuing to rise. Ongoing claims for last week rose to 2.784 million, pushing the four-week moving average of claims to its highest level since October 2005.

That’s led to the Fed raising its forecast for the fourth quarter jobless rate from a range of 4.8 to 4.9 percent to 5.2 to 5.3 percent. That creates concerns that sectors that aren’t directly related to the housing crisis are finally beginning to feel the effects of the slowdown.

 All told, the data we’ve gotten this week continues to point to a weakening economy with no real end in sight. Home builders are still in trouble, and the only real bailout for them will be a prolonged period of lower mortgage rates. But that doesn’t look likely because inflation gauges face upward pressure as food and energy prices continue to soar, so sooner or later rates will have to rise.

And the employment situation will probably continue to deteriorate until all of the other underlying problems are addressed, which will further slow consumer spending.

Any of that sound eerily familiar?

As The Wall Street Journal so deftly pointed out yesterday in Greg Ip’s article Fears of Stagflation Return, this is a very similar situation to what we experienced back in the 1970s. The root causes may have changed, but the economic consequences are much the same. It’s still too soon to say whether or not that’s actually how things will play out. It’s possible that if unemployment levels rise and consumer spending slows, falling demand will naturally combat inflation. But right now the Fed must tread lightly.

Given that the food inflation we’re seeing is largely a result of government mandates for ethanol in gasoline and increased demand from emerging markets, policy makers can’t simply turn a blind eye just because there isn’t much they can really do about. It speaks volumes about the fact that although short-term economic stimulus packages may make for great election year drama, we really have to address the root causes of our problems.

And we’re making strides on that front as lenders work with borrowers to help keep them in their homes. And moves by Congress work to regulate out abusive and irresponsible lending practices. But if we really want to nip the problem in the bud, Congress needs to further expand the scope of the Federal Housing Administration so that they could take more direct action to refinance mortgages for homeowners facing foreclosure.

A plan like that is particularly vital because even if we can patch up the current mess, we can’t lose sight of the fact that another $430 billion worth of adjustable-rate mortgages are due to reset in 2011. So if we don’t take definitive action now, we could find ourselves facing the same problem in another three years. But if we actually fix the problem now, rather than three years from now, the Fed will be in a better position to actually fight inflation and get our economy back on track.

But not all markets are losing propositions, and as Elliott Gue pointed out in his e-zine The Energy Letter, commodities markets are still booming, and coal is performing particularly well.

A year ago, few investors wanted anything to do with the coal markets. Inventories of coal at US utilities were tight at the end of 2005, but a warm winter in 2005-06 changed all that: Inventories ballooned, and coal prices plummeted. Most coal stocks saw declines of 50 percent or more from May 2006 through early 2007.

Now the situation couldn’t be more different. I’ve highlighted the ongoing tightening of supply and demand in the US coal markets before in The Energy Letter and in my paid newsletter, The Energy Strategist. The Nov.16, 2007, issue of TEL, The Great Coal Grab, offers a summary of the forces at work.

Although the coal mining firms aren’t as inexpensive and depressed as they were back then, the fundamentals continue to improve; I see the potential for a further spike higher in coal and coal-related stocks in the coming weeks.

Far too many investors and pundits made the mistake of misinterpreting the fourth quarter earnings releases from the major coal mining firms. Several of the big US-based coal producers either missed or barely met expectations for fourth quarter earnings; the stocks tended to sell off sharply in the immediate aftermath of these reports.

Some investors were puzzled by the seemingly weak results in the face of sky-rocketing coal prices. The reality was that these results were widely expected and nothing new.

Spot coal prices—the price of a ton of coal for immediate delivery—are trading at new highs. US coal supplies have tightened notably over the past year because of a series of new environmental and safety regulations primarily targeting mines near the East Coast of the US.

Smaller miners simply couldn’t shoulder these costs, especially with coal prices so depressed earlier in the year. Many smaller operations shut down entirely, while larger, better-capitalized players scaled back production from their highest cost mines.

At the same time, demand for US coal is on the rise. Ironically, much of this demand comes from abroad. Specifically, China became a net importer of coal in 2007 for the first time in its history. China is already the world’s largest consumer and producer of coal, but consumption has been growing far faster than production in recent years.

The situation became so dire earlier this year that the Chinese government actually banned exports of coal from China, at least temporarily. Then, to make matters even worse, China was struck by its worst snowstorm in 50 years, crippling coal transport infrastructure. The end result: a series of major power blackouts in China as the nation’s utilities literally ran out of coal supplies.

And China isn’t the only country with weather and infrastructure problems. Australia, traditionally the world’s largest coal exporter, was struck by severe rains earlier this year, flooding some of the nation’s key mines. Mining giant BHP Billiton recently noted that it could be six months before those mines are back to full capacity. And even before the rains, Australia was having difficulty staying on top on coal demand because of congested ports.

Then there’s South Africa. Because of serious power capacity shortages, the nation has experienced several blackouts that shut down mining production. South Africa is another key exporter of seaborne coal.

The end result of all these forces is that coal supplies are tight in China, and the Chinese are keen to import more supplies. Any exporters with spare capacity are exporting coal there; however, this leaves Europe in a terrible bind. Traditionally, Europe has relied on seaborne coal shipments to meet demand. But with those shipments headed to Asia, Europe is turning to the US.