BONDS
For the most part, economic news was healthy this week, leading Treasury yields to creep up over the course of the week. The combination of improved jobless claims figures with strong employment components of the ISM surveys led bond investors to fear a whopping nonfarm payroll report. While the employment figures were on the whole decent, they were not outlandish, and this allowed a rally in the bond market today. After all was said and done, bond investors believe that the February employment report supports another 25 basis point rate hike in the fed funds rate, not a faster move that was feared.

Markets at a Glance

Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.

The Economy

Payrolls jump
Nonfarm payroll employment jumped 262,000 in February after posting more moderate gains in the three previous months. The best part of the February employment spurt was that the growth was not concentrated in any one area, but rather broadly based across the various economic sectors. For instance, goods-producing payrolls increased 55,000 in February, more than offsetting the previous month's 17,000 loss. Both construction and factory payrolls posted healthy gains. Although manufacturing payrolls have been falling for several months and the February gain simply recoups a January loss.

Service-providing sectors rose 207,000 in February, the largest gain in four months. Gains were evident in all major categories from retail and wholesale trade to financial services to professional & business services. It has taken four years for payrolls to regain - and surpass the old February 2001 peak. The economic recession was considered mild in 2001 - but one would never know it by the slow recovery in employment.

Average hourly earnings were unchanged as were average weekly hours, at 33.7 for a fourth straight month. Although the employment spurt will help employee earnings for the month, the soft hours and earnings data will curtail the overall gain in wages and salaries. Don't expect a big jump in personal income growth.

The factory workweek fell back to 40.5 hours. Though a 12-minute drop from the January level, it is essentially in line with the pace of the previous few months. The increase in factory payrolls could help boost industrial production nonetheless.

Jobless rate turns higher, employment-population ratio falls
The civilian unemployment rate increased 0.2 percentage points to 5.4 percent, returning to the level seen in November and December. In contrast to January when labor-force growth declined and employment rose modestly, February employment dipped while labor-force growth increased. It isn't unusual to see workers coming out of the woodwork when they see labor market conditions improve. However, it was disquieting to see another drop in the employment-to-population ratio in February. This decline brought the ratio back to last October's level after some improvement in recent months. The employment-to-population ratio recovered more quickly after the 1990-91 recession, a time like now of slow employment recovery.

Nonfarm productivity moderates in 2004
In the past several years, slow employment growth has been blamed on the robust pace of productivity gains. Indeed, notice in the graph below the robust yearly gains from 2002 through the middle of 2004. In the second half of 2004, just as payroll employment was beginning to improve, productivity growth began to moderate. In the fourth quarter, nonfarm productivity was up 2.8 percent, a sharp moderation from the fourth quarter of 2003 when nonfarm productivity gained 5.5 percent.

Productivity gains are a double-edged sword since they improve profit margins and allow wage increases without escalating inflationary pressures. However, robust productivity growth can also prevent employment growth. In the mature phase of an economic expansion, productivity growth moderates. Notice that nonfarm productivity gains were mostly in a 2 - 3 percent range in the second half of the 1990s. It is likely that we will see these types of increases in the next year or so.

ISM surveys
The ISM manufacturing index fell back to 55.3 in February, the third straight monthly decline. While the overall index still reflects an expanding manufacturing sector, it appears that this sector of the economy has moderated this winter. The business activity index from the ISM non-manufacturing survey inched up modestly in February to 59.8. Despite the uptick, the index level remains well below the average of 62.4 posted in the fourth quarter of 2004. Again, the healthy level points to a growing economy even if the pace is somewhat lower than last quarter.

New home sales drop in January
Sales of new single-family homes fell to a 1,106,000 unit rate in January, a 15.2 percent drop from the October peak of 1,304,000. Single-family home sales have fluctuated sharply in the past year. In the past five months, mortgage rates had remained relatively stable. As Treasury yields rise, however, mortgage rates are likely to follow. Indeed, 30-year mortgage rates jumped 10-basis point in the most recent week ended March 3.

A moderation in the housing market is likely to lead to a drop in retail spending on furniture and appliances as well as home furnishings. However, Home & Garden TV has made it fashionable to redecorate frequently and accessorize one's home for the various seasons. Thus, the drop in home sales, at least for home furnishings, may not have as detrimental an effect as in the past. But, then again, one can buy only so many stoves and refrigerators, so appliance sales are likely to be curtailed more dramatically than home furnishings.

Motor vehicles remain sluggish in February
Domestic motor vehicles sold at a 13-million-rate in February, about the same pace as in January. The January drop was to be expected in light of the December spurt. However, automakers were discouraged with February sales and increased incentives on selected models. Nonetheless, the incentives may have been too little too late. Now, automakers are likely to pull back production schedules over the next several months in order to better align inventories and sales.

Consumer attitudes are not necessarily to blame for the less than stellar performance in motor vehicles sales. Though both the Conference Board's consumer confidence index and the University of Michigan's consumer sentiment index fell back modestly in February from January levels. consumer sentiment is relatively optimistic. This may change in the next month or so, though, as gasoline prices head back up after a respite over the past few months. Crude oil prices have skyrocketed over the $50 per barrel mark, and this has led gas prices to head higher once again.

The Bottom Line
Market players have generally worried that strong economic figures would pressure the Fed to raise its fed funds rate target more rapidly than the current pace of 25 basis points. The employment report was generally favorable with a spurt in nonfarm payrolls, but average hourly earnings didn't rise and the jobless rate rose again. This is not a uniformly robust report that should lead to more rapid rate hikes on the part of the Fed.

The ISM surveys reveal that economic activity is continuing to grow at a moderately healthy pace. Motor vehicle sales were disappointing for automakers, and this will lead to some production cuts. The February employment report suggests that monthly production growth was modest once again.

Compared with this past week, the upcoming week will be sparse. Market players are likely to focus on the Beige Book on Wednesday and the international trade figures on Friday.

Looking Ahead: Week of Mar 7 to Mar 11

Monday
Consumer credit increased $3.1 billion in December despite a spurt in motor vehicle sales for the month. Perhaps December credit expansion will be revised higher. In contrast, motor vehicle sales plunged in January, which should hamper total credit growth.

Consumer credit Consensus Forecast for Jan 05: $5 billion
Range: $1.9 to $18 billion

Wednesday
The Fed's Beige Book of current conditions will be reported this afternoon. The most recent one release in January showed some improvement in overall economic activity. Market players will be looking for signs of inflationary pressures as well as the state of current labor market conditions. They will also be interested to see whether retail sales are holding up and how well investment spending is doing.

Thursday
New jobless claims dipped 1,000 in the week ended February 26 to 310,000 bringing the February average to about 307,000. This is a sharp improvement from the January average and is consistent with the February spurt in nonfarm payrolls.

Jobless Claims Consensus Forecast for 3/5/05: 310,000 (unch)
Range: 300,000 to 315,000

The U.S. Treasury is scheduled to release the monthly budget report for February. In January, the Treasury reported a surplus of $8.7 billion, a small one for the month relative to its 10-month average. The February average shows a budget deficit of $57 billion over the past 10 years.

Treasury budget Consensus Forecast for Feb 04: $-97 billion
Range: $-110 to $-94 billion

Friday
The international trade deficit on goods and services narrowed to $56.4 billion in December after surging in the two previous months. In December exports rose but imports were roughly unchanged from November. U.S. demand for goods and services remains strong because economic activity is robust.