Bulls Hurdle Jobs Data Too

Updated from Feb. 1

The post-Fed-meeting rally looks poised to take wing again Friday as the strong-growth, low-inflation story holds water after its biggest test -- Friday morning's January nonfarm payrolls report.

"Investors are like people pulling petals from a daisy," says Sam Stovall, chief investment strategist for Standard & Poor's. "There is inflation, there's no inflation. Right now they're on the 'no inflation' petal."

Traders are staying on the no-inflation petal after the Bureau of Labor Statistics revealed 111,000 new jobs added in the month of January, vs. consensus expectations for 150,000. The unemployment rate rose a tick to 4.6%, from 4.5%. The strongest job growth came from the service sector, while manufacturing jobs continued to decline -- by 16,000 in the month.

Continuing in the pattern of large upward revisions to prior months, the government revised December's print of 167,000 new jobs up to 206,000 new jobs.

Rather than watching the headlines, all eyes were on the average hourly wages component in the report, given its importance to Fed policy. The number was expected to rise 0.3%. Instead, wages rose 0.2%, once again assuaging inflation fears. In December, average hourly earnings jumped 0.5%, or a 4.2% year over year -- well above the two-decade average of 3.2%. The average hourly workweek slipped slightly to 33.8 hours from 33.9 hours.

All in all the report was solid, but not too solid, and this reinforced the so-called Goldilocks growth story. Stock market futures were pointed higher ahead of the 9:30 a.m. EST open. In addition to the macro data, major averages were expecting a boost from the likes of Amazon.com (AMZN Quote - Cramer on AMZN - Stock Picks), YRC Worldwide (YRCW Quote - Cramer on YRCW - Stock Picks) and Electronic Arts (ERTS Quote - Cramer on ERTS - Stock Picks) in the wake of stronger-than-expected quarterly results and/or guidance. Ericsson (ERIC Quote - Cramer on ERIC - Stock Picks) was shaping up to be a drag, however, after CEO Carl-Henric Svanberg said the cell-phone infrastructure market might grow only about 5% this year rather than earlier predictions of 5% to 9%.

Initially, bonds rallied sharply sending yields on the 10-year note below 4.8%. But it is now selling off, and the 10-year yields 4.83%. "It all depends on how you look at the revisions," says T.J. Marta, chief fixed-income strategist at RBC Capital Markets. If you take in the revisions, on the whole payrolls were better than expected, he says. If you look just at this month, they are weaker than expected. "Pick your time frame and trade accordingly."

Wages Hold the Key

Wage inflation is the key to the Fed's on-hold policy. In the FOMC statement Wednesday, the Fed tempered its take on inflation, removing the word "elevated" and describing core inflation as having "improved modestly."

But "watch wage inflation" was the underlying theme of the statement, which read: "The high level of resource utilization has the potential to sustain inflation pressures."

If wage inflation persists, the Fed is loath to ease, says Peter Kretzmer, senior economist at Bank of America.

Economists have seemed befuddled that the 17 interest rate hikes from 1% to 5.25% were doing little to stem the pace of employment growth even though the second and third quarters of 2006 were softer. Friday's report supports "the hope that the Fed's tightening would eventually begin to untighten the labor situation," writes Marta.

But some economists believe that the tight labor market will get even more squeezed. Given the pattern of constant upward revisions, this 111,000 print could well really mean 150,000 or more and back to 4.5% unemployment once the government is really done counting.

Michael Darda, chief economist at MKM Partners, believes unemployment will fall to 4% in 2007. In addition to no signs of a slumping labor market from the initial jobless claims, Darda says the relationship between profits and employment suggests further tightening. Labor market weakness lags the peak in profits by about 13 months, he says. If the peak in profits is happening now, that puts unemployment trending lower throughout 2007.

Economist Edward Yardeni, president of Yardeni Research, goes one step further. He believes unemployment will fall to 3.5% before the year is out, even without wage inflation.

Next week's productivity report will be key to whether Yardeni's prediction is possible. "If productivity is high, that means we are able to live with higher wages," says Stovall. "Productivity offsets, or absorbs, the inflationary pressure of higher wages."

Meanwhile, inflation as measured by consumer prices is trending down. Thursday, the markets celebrated a 0.1% increase in the December core personal consumption expenditures price index. The reading put the Fed's favored measure of inflation at a 2.2% year-over-year pace, lower than the August through October year-over-year highs of 2.4%. In the same report, personal spending rose 0.7%, and income jumped 0.5% -- both larger-than-expected increases.