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Tape Measures Fed's Nerve

Worry swirls that the central bank won't be able to move gradually when raising interest rates.

Updated from 9:32 a.m. EDT

After a much stronger-than-expected employment report Friday, investors are starting to wonder just how "measured" interest rate hikes will be this year.

Financial markets now believe a quarter-point rate increase in June is practically a slam dunk, and talk of a larger move next month or a string of rate hikes this year has begun to swirl.

The economy added 288,000 jobs in March, much better than the 165,000 gain expected by economists. Meanwhile, the unemployment rate fell to 5.6% from 5.7% and payroll data for February and March were revised higher.

Bill Cheney, chief economist at MFC Global Investment Management, said a rate hike in both June and August is a possibility now, although he doubts that will happen.


Federal Reserve

"will have the benefit of another month's worth of data, including the May employment report, before their June meeting," he said. "If those figures show an even more rapidly improving economy, it's not inconceivable (but still unlikely) they could move in both June and August."

In its policy statement on Tuesday, the Fed said any rate increases would come "at a pace that is likely to be measured," signaling that a repeat of 1994 wouldn't be in the cards. Back then, rates moved up 2.25 percentage points in just over nine months.

After the recent jobs data, some investors are worrying that the Fed won't be able to keep its promise. Bonds plunged Friday, with the 10-year Treasury falling more than a point to yield 4.76%, the highest level since July 8, 2002. Stocks were generally mixed.

"I know that there are people speculating about a 50-basis-point move," said Ethan Harris, senior economist at Lehman Brothers. "But it's hard to imagine a number that gets the Fed to go 50 basis points."

Nevertheless, Harris said payroll data for April were excellent. "If you look at the details of this report, it's actually stronger than the March report," he said. "In this one, everything, with the exception of the factory work week, was strong."

Indeed, 61.7% of industries reported rising employment in April. Harris said the consumer price index next Thursday will be just as important as the jobs report in determining what the Fed does. On Friday, oil prices peaked above $40 a barrel, the highest level in 13 years.

While the elevated price of oil likely will push the inflation rate higher, the Fed must be aware that high energy costs have been eating into consumer spending recently.

Steven Wieting, an economist at Smith Barney, said the breadth of employment in April augurs well for continued job gains in the months ahead. But he noted that, even after strong job reports in March and April, a net 2.3 million private-sector jobs have been lost since December 2000, "suggesting potential slack, even with the reported unemployment rate still low."

Meanwhile, Dale Klamfoth, regional vice president at outplacement firm DBM, questioned just how sustainable this pickup in the job market really is.

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"I don't think this is the end of the story," he said. "Two hundred eighty-eight thousand jobs is impressive but we're not out of the woods."

According to surveys that his firm conducted, the average time to find a job in March was five months, up about a month from 2002. He also noted that while some markets were seeing strong job growth, other areas have been "static."

For the most part though, economists said the strong April data suggest the recovery has become self-sustaining. Even those who had called for the Fed to remain on hold this year changed their tune Friday. Merrill Lynch's David Rosenberg said he now expects a rate hike in August, "with the possibility they move in June."

Fed funds futures are now pricing in an 80% chance of a 25-basis-point rate hike in June, up from just over 50% before the jobs data were released.

"You get another report like this next month and unless there's something that's somewhat contradictory,

Fed officials will have to ask themselves if the economy still needs a 1% funds rate," said Josh Feinman, chief economist at Deutsche Bank.

While investors were reacting negatively to the jobs data, the numbers could help President Bush's re-election chances, something that Wall Street, at least, likes to hear. A recent poll showed Bush in a dead heat with Democratic presidential candidate John Kerry. Many traders worry that Kerry will roll back tax cuts enacted by the Bush administration and that Kerry won't be as friendly to big business.

James Glassman, senior economist at J.P. Morgan, noted, however, that the job market is still far weaker than it should be by now.

"Ordinarily, there are 1.2 to 1.3 million people who are coming of working age, so every year we should be creating 1.5 million jobs and in fact we're down 2 million," he said. "That tells me we're 3

million to 3.5 million jobs below where we should be."

In a statement, Sen. Kerry said: "Any step forward in the job market is good news for America's workers, but let's be clear: we still have a long way to go to get America working again. America is still in the worst job recovery since the Great Depression."

Glassman said he expects jobs to continue growing this year, as productivity slows down. Productivity rose a solid 3.5% in the first quarter, making the upward revisions to February and March employment data all the more surprising. March jobs were revised up to 337,000 jobs from 308,000 while February jobs were revised up to 83,000 from 46,000.

The jump in employment last month was due to a substantial increase in several service-providing industries, the Labor Department said. Jobs were also added in the construction and manufacturing sectors.

Manufacturing employment rose by 21,000 in the month, with most of the gain (20,000) coming from durable goods manufacturing. Construction added 18,000.

Professional and business services employment rose by 123,000 in April. Within employment services, temporary help services added 35,000 jobs in April. Retail trade has added 103,000 jobs and employment increased by 30,000 in health care and social assistance over the month. Food services added 34,000 jobs.

Average hourly earnings rose 0.3%, slightly above economists' 0.2% estimate. The average workweek held steady at 33.7 hours but total hours worked rose by 0.3%. The factory workweek fell by 0.3 hours to 40.6 hours.

A separate survey of households showed that 278,000 jobs were added last month. The household survey covers about 60,000 homes while the payroll survey covers over 400,000 businesses. The number of unemployed workers who have been out of work for six months or more fell by 188,000 to 1.8 million.