In any case, equity prices continue to show gains from year-end levels. The Dow is up 3.3 percent, surpassing increases in the S&P 500 (+2.7 percent) and the Nasdaq composite (+2.6 percent). The small cap sector - which fell sharply this week - is still outperforming the rest of the market with the Russell 2000 up 7.9 percent from year-end levels.

BONDS
The bond market has seen a shift in the shape of the yield curve over the past couple of weeks. It began last week, when the curve first became flatter. Now, it is flatter still with the long end (10-year and 30-year yields) higher than the short end (3-month and 2-year yields). However, the middle of the curve (3-year and 5-year yields) is still higher than the long end. According to some bond market pundits, the February employment report was viewed as "market neutral," but in fact, yields ticked higher on Friday.

From an economic perspective, that is, ignoring technical factors that can cause Treasury yields to fluctuate, retail sales, housing starts and industrial production will be the key indicators to monitor in the upcoming week. Everyone agrees that January's housing figures were boosted by unseasonably warm weather. January home sales showed some deterioration and it will be interesting to see follow through in February housing starts. Similarly, robust retail sales in January could be followed by a correction in February, but what will the underlying trend show' Industrial production plunged in January because warm weather spelled low output for utilities. Will the recovery be in line with the trend, or show a better picture in February' While the employment figures did not include any problems from the East Coast blizzard at mid-month, it remains to be seen whether the blizzard dampened other economic activity during the month.

Markets at a Glance

The Economy
FEBRUARY PAYROLLS POST HEALTHY GAINS
Nonfarm payroll employment increased 243,000 in February after a downward revised gain of 170,000 in January and an upward revised gain of 145,000 in December. This pattern of growth over the past three months suggests that momentum is improving in the early months of 2006. Payroll gains were recorded in all major industry groupings. But as soon as an economic indicator is released, the question turns to the future.

Will these healthy employment gains continue in upcoming months' Given the friendly trends in the majority of categories, it's likely they will. The major question mark surrounds construction employment - which incidentally contributed about one-quarter of the payroll gains, on average, in the first two months of the year. We already know that new home sales slid not only in January but are down about 10 percent from their peak levels. Existing home sales, which can also generate construction through remodeling, are also down about 10 percent from their peak levels reached last summer. So at least a portion of payrolls will likely weaken in upcoming months.

Factory payrolls were roughly unchanged in February and are down 48,000 from a year ago. Productivity growth coupled with a lackluster order book over the past year has dampened employment growth in this sector. Outside the aerospace and high tech industries, we have not seen outstanding demand. Consequently, factory payroll gains are not likely to offset any declines in construction payrolls.

The service sector, however, has posted moderately healthy gains in the past few months, particularly in professional & business services, education & health services, leisure & hospitality and financial activities (which includes finance, insurance and real estate). It is true that the real estate sector might see some weakness in coming months along with the slowdown in housing, but the bulk of financial activity payroll growth has been in finance & insurance in the past year anyway. Retail trade has grown only modestly over the past year. The service-providing sector has posted average monthly gains of 143,000 over the past 12 months and there is no reason to believe that this pace should drop off sharply over the next six months.

The average workweek dipped 6 minutes in February to 33.7 hours, but the trend in the workweek has not changed very much over the past 2 1/2 years ranging from 33.7 to 33.8 hours. One would expect a sustained drop in the workweek before a sharp drop in employment since employers are more likely to reduce the number of hours worked in a period of slack demand than lay off workers.

The increased employment of the past several months has also been accompanied by improved wages. Average hourly earnings increased 0.3 percent in February and are now up 3.5 percent from a year ago. This is the strongest year-over-year gain since September 2001. It is obvious that increased earnings benefit workers - they have more money to spend on goods and services. On the flip side, stronger wage earnings are considered bad for profit margins, although corporate profits have been strong over the past year. Accelerating wages can be considered inflationary, but are not considered so when increases are matched by productivity gains. In 2005, nonfarm productivity increased 2.5 percent.

Are the gains in hourly earnings strong enough to provoke the Fed into tighter monetary policy' After the employment report, more than a few Wall Street economists indicated their belief that the Fed will likely increase the fed funds rate target at least two or three more times, bringing it to 5 - 5.25 percent. They cited the rise in earnings as a factor.

JOBLESS RATE TICKS UP
The civilian employment rate edged up to 4.8 percent in February after dipping to 4.7 percent in the previous month. A change of 0.1 percentage points is not considered statistically significant. Perhaps more relevant is the fact that the jobless rate has remained under 5 percent in five of the past seven months. The employment-to-population ratio, which considers employment changes outside of labor force changes, remained unchanged at 62.9 in February. It is beginning the year on a strong note. Indeed, the employment-to-population ratio has averaged 62.8 in the past 12 months, the best 12-month showing since November 2002. Incidentally, the unemployment rate stood 1 percentage point higher (at 5.8 percent) then. This means that the low unemployment rate is a consequence of sluggish labor force participation in this cycle.

On one hand, this suggests that additional people could enter the labor force because labor market conditions have improved - and it would point to more slack in the labor market than is indicated by the jobless rate. However, more than one Federal Reserve official has indicated that they are looking at the current low jobless rate as an indicator of labor market tightness. They are discounting the lower-than-normal (for this stage of the business cycle) labor force participation and not looking for the labor force participation rate to get back to decidedly higher levels.

This means at least some in the Fed are working under the assumption that the U.S. economy has more or less reached full employment. Full employment is typically associated with a jobless rate that cannot be reduced further without igniting inflationary pressures. Full employment, and its measurement, is a controversial topic. For instance, former Fed chairman Alan Greenspan was not a fan of the concept and he ignored the theoretical construct in the 1990s when the unemployment rate was declining sharply and surpassed the measured full employment unemployment rate of 5 percent at the time. Current Fed chairman Ben Bernanke, a former academic, might be friendlier towards the full employment concept (also known as NAIRU for non-accelerating inflation rate of unemployment).

If Fed officials don't believe that additional workers will enter the labor force in coming months, and the economy will continue to grow at a healthy clip, then they will indeed worry that wage growth will accelerate further. Wage growth and consumer price inflation are linked. These figures are sufficient to keep the Fed in their rate-rising mode at the next FOMC meeting on March 27-28. Of course, today's figures weren't going to change the outcome of the March meeting - most analysts and market players had already anticipated that the Fed would raise rates at this month's meeting. The bigger question is when will they stop'

Since the Fed has become more transparent in their policymaking, by offering information in their post-meeting statement (as well as additional information when the minutes are released only 3 weeks later), it is likely the March 28 statement will give a clue on how the Fed is viewing wage and price inflation - and what they intend to do at subsequent meetings. Most economists are now betting on at least two to three more hikes.

REAL ESTATE ASSETS - AND MORTGAGE DEBT - RISE IN 2005
Homeowners' real estate assets increased a whopping 15.1 percent in 2005 - a bit faster than mortgage debt, which grew 14.1 percent for the year. This translated into a 0.4 percentage point increase in owners' equity to 56.3 percent in 2005 from 55.9 percent in 2004. Despite the slight gain in owners' equity, note it still remains low by historical standards. Admittedly, it didn't make sense to cash in on home equity in the early 1980s when mortgage rates were in the double digits. Nonetheless, homeowners don't own as large a portion of their homes as they did then. As interest rates continue to rise, it is likely that consumers will not be tapping into their equity like cash machines. And even economists who don't ascribe to the housing-bubble theory believe that house appreciation will likely moderate in the coming year as activity cools down. Perhaps mortgage debt will grow more slowly in 2006 - and homeowners' equity will improve further.

The Bottom Line
The employment situation was good in February as payrolls and average hourly earnings increased. The uptick in the jobless rate was not significant and the employment-to-population ratio held steady. While healthy employment earnings growth bode well for the economy, the acceleration in wages is something that must be monitored closely by Fed officials. And the FOMC may indeed determine that the acceleration is too much for comfort. Of course, market players didn't need today's employment report to confirm their expectations that the Fed will raise the funds rate target to 4.75 percent at the month-end meeting. Will it be enough to raise rates at the next two meetings as well' Luckily, the FOMC has the luxury of seeing a few more employment (and earnings) reports.

Other economic news was not as positive. Factory orders plunged (on a drop in aircraft orders) and the international trade deficit widened. The one-month plunge in aircraft orders is not a worry - Boeing is in great shape. It is more worrisome, however, that orders outside the aircraft industry are not stronger. The trade deficit is nothing new - it will simply be a bigger drag on U.S. growth this quarter.

Several key indicators are coming up. The current account deficit for the fourth quarter will probably garner some attention, particularly in the foreign exchange market, even though it is old news. Of course, equity and bond investors will closely monitor retail sales, housing starts and industrial production.

Looking Ahead: Week of March 13 to March 17

Tuesday
Retail sales jumped 2.3 percent in January, posting a fifth straight monthly gain. Motor vehicle sales increased 2.9 percent. Excluding autos, sales surged 2.2 percent with strong sales across the board, but also bolstered by a spurt in gas station sales. Typically, large increases in gas station sales are due to rising gasoline prices rather than surging demand. Many analysts believe that February figures will reveal a correction.

Retail sales Consensus Forecast for Feb 06: -0.9 percent
Range: -0.3 to -1.4 percent

Retail sales ex autos Consensus Forecast for Feb 06: -0.5 percent
Range: 0.3 to -1.0 percent

The current account deficit narrowed slightly in the third quarter to show a quarterly deficit of $195.8 billion. The international trade deficit widened sharply in the fourth quarter and this suggests that the current account deficit will deteriorate rather than improve.

Current account Consensus Forecast for Q4 05: $-220 billion
Range: $-208 to $-225 billion

Business inventories rose 0.7 percent in December and another rise is expected for January. Manufacturers' inventories rose 0.5 percent in January after rising 0.6 percent in the previous month. Wholesale trade inventories inched up 0.1 percent in January. Only retail trade inventories are currently missing.

Business inventories Consensus Forecast for Jan 06: 0.3 percent
Range: 0.0 to 0.6 percent

Wednesday
The Empire State manufacturing index was roughly unchanged in February from the January level after accelerating in the two previous months. At 20.3 in February, this survey was pointing to solid growth in manufacturing activity in this Fed region. Many market players consider this a leading indicator for the more well established ISM survey.

Empire State index Consensus Forecast for Mar 06: 18
Range: 12 to 22

Import prices jumped 1.3 percent in January after declining in the two previous months. Oil import prices surged 6.4 percent in January after posting declines in the three previous months. Crude oil prices were lower in February than in January and this could dampen the index.

Import prices Consensus Forecast for Feb 06: -0.5 percent
Range: -1.0 to +0.5 percent

The Beige Book will cover business activity through about the first week of March and will give investors anecdotal evidence on the state of the economy. Each Fed district compiles regional information based on their discussions with local business leaders.

Thursday
New jobless claims rose 8,000 in the week ended March 4 to 303,000, bringing the 4-week moving average up to 293,500. This was the first time in eight weeks in which claims pushed over the 300,000 mark.

Jobless Claims Consensus Forecast for 3/11/06: 298,000
Range: 295,000 to 310,000

The consumer price index increased 0.7 percent in January boosted by a 5 percent spurt in energy prices. Excluding food and energy, the CPI rose 0.2 percent for the month, with slightly higher prices across the board. Crude oil prices were down in February from the January average, but gasoline pump prices weren't down very much.

CPI Consensus Forecast for Feb 06: 0.1 percent
Range: 0.0 to 0.4 percent

CPI ex food & energy Consensus Forecast for Feb 06: 0.2 percent
Range: 0.1 to 0.3 percent

Housing starts surged 14.5 percent in January to a 2.276 million-unit rate with gains in single-family construction as well as multi-family construction. An unseasonably warm January meant a strong month for starts even though home sales fell. Look for a drop in housing starts in cold, snowy February.

Housing starts Consensus Forecast for Feb 06: 2.00 million-unit rate
Range: 1.95 to 2.10 million-unit rate

The general business conditions component of the Philadelphia Fed's business outlook survey increased to 15.4 in February from a level of 3.3 in January. While the overall levels are somewhat lower than the Empire State manufacturing survey, any level above zero represents growth in manufacturing activity.

Philadelphia Fed survey Consensus Forecast for Mar 06: 14
Range: 4 to 18.3

Friday
The index of industrial production fell 0.2 percent in January because unseasonably warm weather caused a sharp drop in utilities production. Look for a rebound in February. Factory payrolls were roughly unchanged in February although the workweek rose. This could mean a modest gain in manufacturing production for the month. Coupled with a rebound in utilities, the overall gain could be healthy.

Industrial production Consensus Forecast for Feb 06: 0.9 percent
Range: 0.5 to 1.3 percent

Capacity utilization rate Consensus Forecast for Feb 06: 81.5 percent
Range: 81.2 to 82.1 percent

In February, the University of Michigan's consumer sentiment index fell 4.5 points to 86.7. Even though labor market conditions have generally improved, consumers may be feeling less confident about the economy with rising interest rates.

Consumer sentiment Consensus Forecast for mid-Mar 06: 88
Range: 86 to 90