Updated from 8:46 a.m. ET

This wasn't what the market was expecting.

Nonfarm payrolls rose by 135,000 in February, outpacing expectations, as the labor market displayed more strength than economists expected during the month. The service-producing sector continues its resilience, as jobs added in the retail, service and government sectors offset ongoing weakness in the manufacturing arena. The unemployment rate remained unchanged at 4.2% in February, and average hourly earnings rose 0.5%.

Economists had expected payrolls to grow 68,000, for the unemployment rate to come in at 4.3%, and for average hourly earnings to rise 0.4%.

Stocks reacted to the report. The interpretation here seems to be that the market believes that this will cause the

Federal Reserve to ease off its pattern of aggressively cutting interest rates. And this report could give the Fed pause; however, with labor market data generally regarded as a lagging indicator, the chances that the Fed will cut the

fed funds rate, currently 5%, by 50 basis points on March 20 remain strong.

"This is not a report consistent with an economy that's contracting," said Josh Feinman, chief economist at

Deutsche Asset Management Americas

. "This economy is growing very sluggishly now. If this were to persist, the unemployment rate would gradually inch up over time; by the end of the year it could get up to about 4.75%."

But while stocks seem to be distressed that this report wasn't as weak as expected, by standards of the recent economic boom, this isn't a strong report. Job growth continues to slow, and the manufacturing sector is clearly in a recession. Looking at the 12-month average, payrolls are currently rising 146,000 per month. That's not bad, but it's sharply lower than February 2000, when the 12-month average was 217,000.

Other recent economic releases have also displayed a bit more stability in the economy than what the markets had originally thought, including recent auto sales and retail sales data. The data tell a bit of a different story than the gloomy, day-by-day warnings from various technology companies talking about sagging demand for goods.

So the early judgments that the entire economy has slipped into recession seem premature. But it could be that improved productivity and the cutback in hours worked, for now, are sufficient to offset declining demand. Hours worked have declined significantly, especially in the manufacturing sector; weekly manufacturing overtime hours are currently 3.8 hours a week, the lowest since 1992.

"We were worried that for the first quarter, we'd show no GDP gain, but lots of labor input," which would erode productivity, said Steve Wieting, senior economist in

Salomon Smith Barney's

institutional equities group. "It's showing a lot of flexibility; a lot more than we'd thought."

Still, declining demand for goods has clearly hit the manufacturing sector hard, and that includes technology companies that make goods as well. The manufacturing sector lost 94,000 jobs in February after losing 96,000 in January, and over the last six months, the sector has lost 310,000. While that's mostly been concentrated in a decline in hiring in the automotive sector, it also illustrates weakness in other parts of manufacturing. The data confirms the anecdotal evidence in the

National Association of Purchasing Management's

purchasing managers' index, which shows the manufacturing sector to be a recession.

Given the overall tone of weakness, economists still believe the Fed will cut the fed funds rate by 50 basis points at the March 20 meeting. And the

fed funds futures contract, the market's best determinant of what people are thinking with regard to monetary policy, still puts the odds on 50 basis points. But the chatter about a potential 75 basis-point cut is eliminated now.

Friday's report also shows that average hourly earnings continue their steady upward climb. The concern among economists is that a quick rebound in growth and by extension, demand for labor, would realize greater wage increases, making inflation rather than the threat of recession the problem. On a year-over-year basis, average hourly earnings are rising at a 4.1% rate, up from 4% in January. This is the fourth-consecutive month where the year-over-year trend has been at or above 4%.

The service-producing sector, which includes retail trade, government jobs and services, rose by 210,000, after gaining 154,000 in January. Service sector jobs rose 95,000, after a revised 87,000 increase in January, owing to large gains in the health-services sector and a rebound in business services, which had lost jobs for four months running.

Construction jobs gained 16,000 after a revised 158,000 gain in January, a figure that was revised higher from 145,000. Construction jobs have increased as the weather has improved in most parts of the country.