• Payroll employment rose 167,000 in December, well above expectations.
• October and November were revised up by a net 29,000 jobs.
• The unemployment rate held steady at 4.5%.
• Manufacturing and construction shed workers, but the service sector continued to drive the job market forward.
• Average hourly earnings rose a larger-than-expected 0.5%, and the yearly growth in earnings reached 4.2%. Earnings are running well ahead of inflation.
• There was nothing in the report to change the terms of the debate at the Fed, which is whether to hold rates steady or raise them, not whether to cut.

December's employment report was rock-solid. The 167,000 payroll employment gain was well above expectations, which had been for an increase of around 100,000. The scare caused by the weak ADP survey turned out to be just that—a scare (for the record, ADP reported a 40,000 decline in private employment; the official figure was a 150,000 gain).

The report shows an economy holding up well despite the hit from the downturn in the housing sector and the auto industry, generating enough employment and wage gains to support consumer spending.

There was weakness where expected, in manufacturing and construction, although less severe than in October and November. Manufacturing lost 12,000 jobs. Construction lost only 3,000 jobs, with losses in residential construction almost offset by gains in nonresidential building and heavy and civil engineering construction. Unusually warm weather may have supported construction jobs last month (and will do so again in January, based upon the warm weather so far this month).

The service sector continued to power ahead, generating 178,000 jobs (161,000 of those in the private sector). There was strength almost across the board, with the exception of the retail sector, which lost 9,000 jobs (probably a payback for an unusually large 39,000 increase in November). Health services (31,000 jobs) and food services and drinking places (23,000 jobs) were strong yet again. Within the "professional and business service" category, a robust 50,000 jobs were created, roughly evenly split between "higher-end" professional and technical services (23,000) and "lower-end" administrative and waste services (26,000). Within the "lower-end" grouping, temporary help services rose 15,000, its best month since May.

Total hours worked in the economy rose 0.2%, which with some upward revisions to previous months delivered a 2.2% increase in hours worked for the fourth quarter, up from 1.1% growth in the second quarter. Global Insight projects 2.4% real GDP growth for the fourth quarter, pointing to another quarter of weak productivity growth.

Sluggish productivity growth combined with faster wage increases will keep the Federal Reserve alert on the inflation front. Average hourly earnings rose 0.5% month-on-month and 4.2% year-on-year in December (not bettered since November 2000). That is good news for workers, since earnings growth is now well ahead of CPI inflation (2.0%), driving consumer spending power higher. But faster earnings growth combined with slower productivity growth adds up to faster growth in unit labor costs, which would mean higher inflation if passed through to prices. For the moment, this is just something for the Fed to keep an eye on, not an immediate danger. Profit margins are wide enough to absorb some acceleration in labor costs. The bottom line for the Fed is price inflation, and the latest core CPI readings have been benign. In addition, commodity prices (notably oil and copper) have been sliding.

The household employment survey showed the unemployment rate steady at 4.5%, with both household employment (up 303,000) and the labor force (up 326,000) sharply higher. For the fourth quarter overall, the household survey shows an average monthly job gain of 340,000, far higher than the average 136,000 gain in the payroll survey. When two official employment measures of very similar concepts show such divergence, it is hard to know what to conclude. We suspect that the payroll survey is the more accurate measure—but neither measure suggests that the housing and auto downturns have prompted a breakdown in the jobs market.

There was nothing in this report to change the terms of the debate at the Fed (which is whether to hold rates steady or raise them). A first-quarter rate cut is now out of the question and the odds of a second-quarter cut are receding. Global Insight's January baseline forecast incorporates three 25-basis-point rate cuts, beginning in the second quarter, and unless new evidence emerges over the rest of the month showing surprising weakness, the February forecast will scale back the rate cuts.

www.globalinsight.com

www.wmrc.com