Job growth was basically in the sweet spot in December, with payrolls expanding much more than expected.

The gain of 167,000 was 67,000 more than the consensus forecast and about 100,000 more than where the market was leaning, as evidenced by the economic derivatives auction that took place this morning at the Chicago Mercantile Exchange. Previous months were revised upward, making the headline gain even stronger.

The source of payroll strength continues to be the service sector, which added 178,000 jobs in December. The health care sector also remained a top source of job growth, adding 38,000 jobs during the month. There was also strength in administrative and waste services, which added 26,000 jobs, thanks largely to a gain of 15,000 temporary jobs.

Today's data further reduce the odds of an interest rate cut from the Federal Reserve, but they do not significantly raise the odds of a rate hike.

One of the more compelling reasons why today's report lowers the odds of a near-term rate cut is the strong growth in hourly earnings, which increased 0.5% in December vs. the consensus of a 0.3% rise. That puts the gain at 4.2% vs. a year earlier, only slightly below the 23-year high of 4.4% set in 1998 and 1990. The wage gain reduces the importance of the recent decline in commodity prices, given the heavy weighting that labor costs play in the inflation process.

The depth of the bond market's selloff will therefore likely be limited unless a collection of strong data arrive to indicate accelerating economic activity. Strength in upcoming data would raise fears in the bond market of hawkish testimony from Fed Chairman Ben Bernanke when he delivers his semiannual monetary policy report to Congress sometime in February.

Two Kinds of Bond Selloffs

The stock market has to contend with two kinds of bond selloffs, and one is more favorable than the other:

  • The first type, which has recently been seen, occurs in response to indications of continued economic expansion -- in other words, no recession.

  • The second, not seen in a while, occurs when the bond market becomes fearful of future interest rate hikes.

Today's selloff falls under the type that indicates continued economic expansion, with no rate hike in sight. This should limit the bond market's selloff as well as its impact on the stock market, as long as upcoming news doesn't tilt toward a meaningful acceleration of economic growth.

Housing's Impact on Employment

A top focus these days is on housing. Wthin the payroll report, the negative impact from housing hasn't yet materialized in any meaningful way. In December, there could well have been distortions, however, owing to the unusually tranquil weather, which has enabled the completion of projects previously put in place. It could be why construction lost only 3,000 jobs during the month, after decreases of 25,000 and 28,000 in the two previous months.

The nonresidential construction sector continued to provide at least a partial explanation for the lack of deeper job losses, adding 5,000 jobs in December, compared with a loss of 6,000 for the residential sector. Similarly, a decrease of 10,000 residential specialty trade contractors was partially offset by an increase of 3,000 nonresidential specialty trade contractors.

Job losses in the construction sector will almost certainly accelerate in the months ahead, with many expecting the losses to reach 500,000 or more in 2007. Two factors could limit those losses, however.

The first is the growth in jobs in the nonresidential sector. The second is the fact that at housing's peak, there was actually a shortage of skilled construction workers, which should reduce the amount of layoffs that occur.

A continued oddity is the growth in jobs held by credit intermediaries, which include mortgage brokers. The gain for this category was 5,000 in December.

Also interesting is the continued strength in household employment, which is picked up by the separate household survey that produced today's 4.5% unemployment rate (unchanged from November). In December, household employment expanded by 303,000, after gains of 286,000 and 431,000 in November and October, respectively, and gains of 288,000 in both September and August. The strength hints at fairly solid levels of net business formation. When new businesses are created, it takes time for them to become part of the payroll survey, yet the workers could get picked up in the household survey relatively fast.

Why ADP Missed

Today's report is much stronger than the whispers, which leaned toward a lower number following ADP's weak forecast Wednesday, which expected payrolls to show a decline. ADP itself said it might have difficulty forecasting December payrolls: "Employment records get cleaned up in December, and this involves jettisoning the names of people who left earlier in the year, so employment tends to decline in December among firms in ADP's sample. So if there was one month where seasonal adjustments might be a source of uncertainty, December would be it.''

Given today's divergence between the ADP data and the payroll change, as well as ADP's underestimation of about 100,000 in December 2005, investors are sure to downgrade ADP's December data a year from now.
Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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