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A late pullback in oil prices allowed the major indices to squeeze out minor gains on Thursday, but the enthusiasm was tempered by inflation jitters ahead of Friday's key May employment report.


Dow Jones Industrial Average

rose 3.62 points, or 0.03%, to 10,553.49. The blue-chip index was pressured by


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, which was downgraded by Deutsche Bank, and

J.P. Morgan

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, which saw earnings estimates fall.


S&P 500

index rose 2.07 points, or 0.17%, to 1204.29. The


gained 9.94 points, or 0.48%, to 2097.80. The tech-heavy index once again led the late advance. Two tech mergers helped fuel buying interest.

Sun Microsystems

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agreed to acquire

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for $4.1 billion; and


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said it will buy

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for $620 million.

The indices bounced from lows as crude oil pivoted in afternoon trading, providing a bit of relief to previous jitters over inflation. The return of higher oil prices over the past few weeks has flown in the face of a firming dollar, which normally puts pressure on the price of commodities. But Thursday, crude oil for July delivery fell 97 cents to $53.63 a barrel on Nymex, after bearish inventory data.

Stocks were under pressure earlier in the session after a revision to first-quarter productivity numbers showed labor costs rose more than previously expected. After dreaming Wednesday that the


may end its tightening schedule sooner than thought, investors woke up Thursday.

Unit labor costs increased a revised 3.3% in the first quarter, way above previous estimates of a 2.2% rise, surprising economists who expected the number to be revised down to 2%. That is bad news for those hoping the Fed will pause or even halt its rate-tightening schedule anytime soon. Labor costs account for 70% of inflationary pressures.

But there's still hope for those seeking an end to rate hikes. In order for inflation to be sustained, there needs to be job growth. The May ISM manufacturing index on Wednesday showed that the sector, which still represents 20% of the GDP, is close to contraction.

And on Thursday, jobless claims rose to 350,000, well above forecasts that claims would rise to 325,000. There are no worries for growth, however, according to the Labor Department, which mentioned that "a significant portion" of the increase came from layoffs in the auto sector.

Fair enough. Economists say that jobless claims don't always predict payroll growth accurately anyway. So the May employment report on Friday is key. Economists on average expect the economy to have added 178,000 jobs in May, according to Reuters. Some analyst forecasts call for payroll growth of up to 225,000.

Still, Thursday's mixed picture may explain why the benchmark 10-year Treasury bond fell only slightly after rallying sharply over the past couple of sessions. The bond lost 2/32 while its yield rose to 3.89%.

The bond market still appears to be downplaying inflation risks and it is usually


best market instrument for measuring these risks.

Clearly if the employment report shows explosive growth in employment, a revision of these expectations might be in order. But in the meantime, there is cause to believe that the inflationary implications of employment growth are currently less meaningful than in the past.

Tighter labor markets normally push wages higher and fuel consumption. But as mentioned here after last week's revision of the first-quarter GDP growth, some economists believe that higher employee compensation in the first quarter was not the result of higher wages. Instead, it came from bonus pay and stock options exercises after a strong performance by Wall Street in 2004. Whether that fuels widespread and sustained consumption remains to be seen.

According to the International Council of Shopping Centers, same-store sales rose just 2.9% in May from the same month last year, just short of the ICSC's estimate for a gain of 3%-3.5%.

Another way higher labor costs contribute to overall inflation is that they pressure businesses to raise prices or else take a hit on profit margins. But a very competitive pricing environment has kept a lid on price increases for many companies.

For instance, it was a drop in clothing and computer prices that explained why consumer prices, excluding food and energy, were unchanged in April. And the rally of the past few weeks in stocks and bonds, after all, was unleashed after that tame April CPI report.

That's not to say that consumer prices, and inflationary pressures, are not rising. The year-on-year gain in core prices, while falling back from a 2.4% rate in March, was still 2.2% in April. That rate of inflation is still acceptable for the Fed but it would have to stay at those levels or continue declining to be truly meaningful.

Of course, the other reason the Fed needs to keep raising rates -- even in the face of a potentially contracting manufacturing sector and moderate inflation -- is that rates simply are still near historic lows, and are still fueling asset-based inflation (i.e., housing).

In other words, the market may rally Friday if the employment numbers come in at or below expectations, on the belief that inflationary pressures are contained. But that wouldn't mean the Fed won't continue raising rates. Likewise, the market may come under pressure if payroll growth is "too high." But it won't mean the Fed will raise rates more aggressively.

To view Gregg Greenberg's video take on today's market, click here


In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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