The August jobs report brought mixed messages. The unemployment rate jumped by three-tenths of a point to a 26-year high of 9.7%, but the rate of payroll job losses slowed again, from 276,000 in July to 216,000. Which matters most? We think that the key message is from payrolls, which show less severe cutbacks, especially in private services. The jump in the jobless rate is unpleasant, but the drop in July had been too good to be true, so this month's rise is not shocking.

The overall payroll decline of 216,000 was slightly better than expected, although the June and July payrolls were revised down by a combined 49,000. Notably, all of the bad news in the revisions came from state and local governments, where June and July were revised down a combined 54,000.

The most striking shift in the payroll numbers was in the private services sector, where cutbacks were most extreme earlier in the year. This month's job loss was just 62,000, the smallest decline since April 2008. During the first quarter, this sector was shedding jobs at a rate of 358,000 per month.

Education and health services added 52,000 jobs, with an unusual 20,000 increase in social assistance. Very few other service sectors actually added jobs, but most saw slower rates of decline. Transportation and warehousing shed 1,000 jobs, compared with 24,000 in July. The retail sector shed 10,000, compared with 43,000 in July. Retail employment benefited a 5,000 increase at auto dealers, probably helped by the cash-for-clunkers sales surge, but likely to prove fleeting as a result. Temporary help jobs fell 7,000, little different from July, so we have not quite yet moved into the plus column for these jobs, which would be a leading indicator of broader gains elsewhere.

The manufacturing and construction sectors continued to shed jobs, and at a slightly worse pace than in July, although that was due to seasonal quirks in the auto industry figures. Manufacturing cut 63,000 jobs in August, compared with 43,000 in July. We have not seen back-to-back declines below 100,000 since August-September 2008. The deterioration this month came from motor vehicles and parts, where employment fell 15,000, after rising 31,000 in July. The unusual jump last month was due to seasonal adjustment quirks—the usual summer shutdowns came earlier than July this year. If we exclude motor vehicles and parts, then the manufacturing figures show an encouraging trend, with a loss of 102,000 jobs in June followed by 74,000 in July and 48,000 in August. Very few manufacturing sectors added jobs this month, but most saw slower rates of decline.

The manufacturing workweek held at 39.8 hours, after a jump from 39.5 hours in June. Overtime hours were also steady. Overall manufacturing hours worked fell 0.5%, which is disappointing after the upbeat signal from the ISM survey earlier in the week. But we still believe that manufacturing output hit bottom in June and is now on the way up, because the inventory cycle has turned.

Construction payrolls fell by 65,000 in August, compared with a 73,000 loss in July. The losses were heavier in nonresidential construction (down 35,000) than in residential construction (down 23,000), continuing the recent pattern. This is not surprising, since nonresidential construction has much further to fall, while residential construction is beginning to flatten out. There were 8,000 jobs lost in heavy and civil engineering construction, where one might hope to see the impact from fiscal stimulus coming through—but one cannot know how many jobs would have been lost without the stimulus.

Although the private-sector news is getting better, the news on government jobs is getting worse. Revisions to recent data now show state and local governments shedding 79,000 jobs over the past three months as budget cuts bite, with most of the cuts in education. The advent of the new fiscal year in July probably explains the steep 37,000 loss in that month.

The unemployment rate rose sharply, mainly because the household survey showed a much bigger decline in employment (down 392,000) than the payroll survey (down 216,000). In addition, some workers (73,000) returned to the labor force after the big drop last month. The most comprehensive measure of underemployment—which includes workers who would like a job but are not currently looking, plus those working part time who would rather work full time—rose from 16.3% to 16.8%.

Total hours worked in the private sector fell 0.3% this month, a disappointment after the 0.1% increase in July, and bad news for household incomes. There was some offset, though, in that average hourly earnings rose 0.3% for the second successive month, helping consumer spending power. Hours worked appear to be running around 2–3% lower than in the second quarter, a much milder decline than the 7.8% drop in the previous quarter, but emphasizing that if GDP is to grow in the third quarter (which we think it will, by 3.7%) the increase will be driven by another outsized gain in productivity.

The bottom line is that the rate of decline in employment is slowing, and is likely to continue to do so over the rest of 2009. But we will need to see sustained employment gains before concluding that unemployment has peaked, and that probably won't be until the first half of 2010, with the rate at least 10%. With the workweek flat and temporary help still declining, there were no leading indicators in the report suggesting that the economy will actually be adding jobs this year.