Coming Week: Not There Yet

Despite initial optimism in the jobs market and in the credit markets last week, the U.S. economy has a ways to go to cure what ails it.
By Nat Worden ,

Wall Street's latest burst of exuberance had investors hoping on Friday morning that the fourth straight month of declines in the job market was a positive sign for the U.S. economy.

It wasn't.

The economy

shed 20,000 jobs

in April, according to the Labor Department. Economists on Wall Street had predicted a decline of 80,000, so the report prompted a momentary rally in the stock market after the opening bell that quickly dissipated as reality set in.

"April payrolls were down just 20,000, but this masks the fact that most components declined substantially in the month," said Joseph LaVorgna, chief U.S. economist with Deutsche Bank.

Sectors like manufacturing, construction, transportation and retail all posted sizeable declines in jobs. The gainers included the services sector, health care and education, government and, surprisingly, financial services.

"How in the world is it possible that the financial sector added jobs last month?" asks Paul Mendelsohn, chief investment strategist with Windham Financial Services. "This report was not a positive in my mind. Previous months were revised lower, and there's no sign that the labor market is improving."

As those sentiments spread through the markets, Friday morning's rally gave way to mixed trading as most investors waited for news on the negotiations surrounding

Microsoft's

(MSFT) - Get Report

bid to acquire

Yahoo!

(YHOO)

, an effort aimed at helping the tech giant compete with

Google

(GOOG) - Get Report

in the fast-growing online ad market.

Next week, investors will be looking for new reasons to extend Wall Street's stock rally. Despite Friday's pullback, the

Dow Jones Industrial Average

ended the week with a total gain of 1.3%. The

Nasdaq Composite

added 2.2% for the week and the

S&P 500

gained 1.1%.

The stubborn credit crisis on Wall Street, like the economy, also has improved, but is far from being well.

T.J. Marta, fixed income strategist with RBC Capital Markets, notes that credit spreads indicate the financial markets are "less dislocated than they were," and he says "we've survived the worst of this storm." Such sentiments have led to speculation that the

Federal Reserve

will keep its 2% federal funds rate target in place at its next meeting in June amid rising signs of inflation. That view was bolstered last week by the Fed's latest

policy statement

, in which the central bank removed a previous reference to "downside" risks to growth, while noting that past federal funds rate reductions and "ongoing" liquidity measures should help spur an economic recovery.

Friday, however, showed that the Fed is still busy

pumping liquidity into shaky markets

at home and abroad. It announced that it was increasing the size of some cash auctions for financial institutions through its term auction facility and the amount of dollars it provides to the European Central Bank and the Swiss National Bank. Also, the Fed said it will lower its standards on collateral it will accept for term securities lending facility loans to include AAA-rated asset-backed securities.

"The Fed has thrown a lot of things at the wall to see what would stick in this credit crisis, and the

term auction facility auctions and the swap lines are the things that seem to be working the best, and so the Fed is ramping those up," says Marta. "They seem to have the right combination, and going forward, we're going to see spreads continue to normalize."

Crude oil futures responded to the Fed's actions by rallying up $3.80, or 3.4%, to settle at $116.32. Gold also rallied on speculation that the dollar's recent rebound will prove short-lived.

"The Fed's primary concern here is repairing the credit system and they're willing to tolerate inflation for a while to do that," says Joseph Brusuelas, chief economist with Merk Investments.

This week, another batch of first-quarter earnings are in store, with companies like

Walt Disney

(DIS) - Get Report

,

Fannie Mae

( FNM) and

UBS

(UBS) - Get Report

on tap.

Investors will be increasingly focused on the weak dollar and oil prices as a sign of how financial markets and consumers will fare as the economic downturn runs its course.

On Monday, economists expect the Institute for Supply Management to report that its index tracking economic activity in the service sector ticked down to 49.5 in April from 49.6 in the previous month. Then the government is expected to report that first-quarter productivity slowed to a 1.2% growth rate from 1.9%.

On Thursday, the government is expected to report that wholesale inventories grew by 0.4% in March, and then on Friday, the government is expected to report that the U.S. trade gap narrowed to $61.3 billion that month.

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