BONDS
During the week, bond investors became increasingly worried about the potential for inflationary pressures and "decided" that the Fed will probably have to become more aggressive in their rate hikes in coming months. Bond investors began to suspect that the post-FOMC meeting statement on December 14 would indicate as such.

But the employment situation was released on Friday - and turned the market topsy-turvy. Yields fell between 10 and 15 basis points across the maturity spectrum because nonfarm payroll employment grew much less-than-predicted in November - plus September and October payrolls were revised down. Bond investors are less worried today than they were yesterday about aggressive Fed rate hikes.

Bond investors believe that "bad" economic news is good for the bond market because it implies that inflationary pressures are not as ominous. However, bond investors should be concerned about the plunging value of the dollar in the foreign exchange markets. The dollar is a moving target - with new lows against the euro reached hourly! By Friday's close, the euro cost $1.3458 (conversely, a dollar is only worth 0.743 euros). The dollar also declined against the yen and the British pound, among other key currencies. A depreciating dollar is usually good for the export market but not for the import market since imports cost significantly more to consumers as the FX value of the dollar declines. Thus, we import inflation. Furthermore, demand for U.S. securities diminishes as the dollar plunges because foreign investors become less interested in a depreciating asset. Higher interest rates may then be needed to entice buyers of U.S. bonds.

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 slumps again
Nonfarm payroll employment increased by a moderate 112,000 in November after downward revised gains of 303,000 in October and 119,000 in September. Not only were September and October payrolls reduced by 54,000, but November payrolls grew significantly less than predicted by economists. Once again, payroll growth was a disappointment. The goods-producing sector yielded a modest 8,000 gain in payrolls as construction employment increased by a modest 11,000 and manufacturing employment decreased by 5,000. The service-producing sector netted a gain of 104,000 despite a drop of 16,000 in retail trade. Gains were generally modest across service industries, including a small 9,000 rise in temporary help. Though companies are nervous about hiring, they may find their sales to be sluggish since unemployed workers have limited resources to spend on goods and services.

A drop in the average workweek accompanied the sluggish payroll growth. The private workweek lost 6 minutes in November to average 33.7 from 33.8 in both September and October. The factory workweek also decreased by 6 minutes in November to 40.5. Here the trend is more troublesome as the average factory workweek stood at a level of 40.9 hours just three months prior. Not only is employment growth moderating, but companies appear to be scaling back hours worked as well. This is not a good trend.

Jobless rate dips again
The unemployment rate edged down to 5.4 percent in November after inching up to 5.5 percent in October. A change of 0.1 percentage points is not considered statistically significant - and in fact, one can say that the jobless rate has remained in a tight range (5.4 to 5.5 percent) for the past six months. The October rise in the jobless rate was due to a little spurt in labor force growth that was not matched by an equal gain in employment. In November, both household employment and the labor force spurted! It isn't unusual to see monthly divergence between household employment and nonfarm payrolls: the two employment series don't grow in tandem each and every month, although over time, they tend to move in the same general direction.

We like to look at the employment-population ratio, which allows one to track employment growth without worrying about monthly variation in labor force movement. The employment-population ratio jumped 0.2 percentage points to 62.5 in November. Notice that this ratio still remains relatively subdued judging by the recent past. When the jobless rate was at the same level in 2001, the employment-population ratio was about a half point higher than it is today. But it does appear that the employment-population ratio has been slightly higher, on average, over the past five months relative to the prior five months. Improvement is slow, but it is there. In our view, the employment-population ratio more accurately reflects improvement in the labor market than the jobless rate since discouraged workers are not counted in the jobless rate until they feel better about economic conditions and start looking for work.

Purchaser surveys
The NAPM-Chicago's business barometer fell back to 65.2 in November after surging to a level of 68.5 in October. In contrast, both the ISM manufacturing and non-manufacturing indexes rose moderately in November from October. Over the past four months, the ISM manufacturing index has remained in a tight range of 56.8 to 59. The non-manufacturing index, which measures activity in the service sector including construction, mining and utilities, has shown more improvement and a wider range (between 56.7 and 61.3) over this same four-month period. Overall, it does appear that manufacturing and non-manufacturing activity is on an improving trend over the past couple of months at least, but not quite up to the pace we saw in the spring of this year.

Motor vehicle sales remain on trend
Just like nonfarm payroll growth, motor vehicle sales have jumped around from one month to the next - sometimes posting robust sales and sometimes dropping like a rock. In fact, the 12-month average of motor vehicle sales hasn't changed very much over the past several months. Sales were weaker in 2003 than in 2004. But the monthly sales pace is highly governed by incentives. Strong incentives do generate healthy sales, while the removal of these incentives reduces showroom traffic. Unless employment growth begins to show a true recovery (which we have not really seen despite a month or two of robust gains), then motor vehicle sales aren't likely to penetrate into the higher realms that manufacturers would like to see.

Q3 GDP revised up
The Commerce Department barely revised up its estimate of third quarter GDP to a 3.9 percent pace from the advance estimate of 3.7 percent. Personal consumption expenditures as well as business fixed investment were both revised up, but residential investment spending, along with the change in business inventories and government spending, were revised down. The net export deficit was revised down as well, and that helped to make it less of a drag on total domestic growth. Real final sales, which measure GDP less the change in business inventories and offers a signal on demand, grew at a 4.9 percent rate, up from the initial estimate of a 4.2 percent rate.

The Commerce Department's initial reading of corporate profits shows a slowdown from the previous quarter. The chart below depicts year-over-year gains in after-tax corporate profits. In the second quarter, after-tax profits grew 19.5 percent but moderated substantially in the third quarter to post a 9.5 percent yearly gain. No doubt, profit margins suffered from higher energy costs during the third quarter. This may play a role in holding down fourth quarter profits as well. Companies are also hoping to get healthy holiday sales, but are thus far disappointed.

The Bottom Line
Once again, the employment statistics were a disappointment. November growth was weaker than expected and the two previous months were revised down. The jobless rate has remained remarkably stable - but this probably reflects the fact that discouraged workers are not confident enough to enter the work force to start looking for jobs. The employment report often sets the tone for the monthly set of economic indicators - and this report promises soggy figures ahead.

Other news was mixed. The ISM surveys were friendly showing improvement from the previous month. Motor vehicle sales were less than stellar, although considering the lack of employment growth (that would generate new potential buyers), they have remained relatively stable over the past year.

Several key indicators will be reported in the coming week. Market players are likely to focus on productivity and inflation figures. The PPI would certainly garner a lot of attention next Friday.

The FOMC will be meeting on December 14. Before the November employment report, bond investors convinced themselves that the Fed would begin tightening more aggressively. After the anemic report, they decided that the Fed can remove policy accommodation at a measured pace. Who knows' But surely, the bond market has another week's set of numbers to consider that include inflation news - and so does the Fed.

Looking Ahead: Week of Dec 6 to 10

Tuesday
Nonfarm business productivity rose at a 1.9 percent rate in the third quarter. Given minor revisions in GDP growth for the same period, revisions for productivity may also be relatively small. Unit labor costs grew at an initial .6 percent rate in the third quarter. The growth rate will be affected if there are changes in productivity growth.

Nonfarm productivity Consensus Forecast for Q3 04: 2 percent annual rate
Range: 1.9 to 2.2 percent annual rate

Unit labor costs Consensus Forecast for Q3 04: 1.6 percent annual rate
Range: 1.4 to 1.6 percent annual rate

Consumer credit increased by $9.8 billion in September after a much smaller gain in August. The October level should moderate since motor vehicle sales plunged in October and this plays a major role in credit demand.

Consumer credit Consensus Forecast for Oct 04: $6 billion
Range: $3 to $7.1 billion

Thursday
New jobless claims jumped 25,000 in the week ended November 27 to 349,000 after declining in the two previous weeks. The 4-week moving average inched up to 336,500. Claims were on an improving trend until this latest week, but remember that claims are notoriously difficult to adjust for seasonal variation at this time of year.

Jobless Claims Consensus Forecast for 12/4/04: 335,000 (14,000)
Range: 325,000 to 340,000

Import prices jumped 1.5 percent in October - largely due to a spurt in energy prices. Non-oil import prices actually dipped 0.2 percent for the month. Import prices are available before the PPI and CPI and can serve as a leading indicator.

Import prices Consensus Forecast for Nov 04: 0.1 percent
Range: -1.2 to +0.5 percent

Export prices Consensus Forecast for Nov 04: NA
Range: NA

Friday
The producer price index jumped 1.7 percent in October due to a surge in energy prices as well as higher food prices. Excluding food and energy, the PPI rose 0.3 percent, still a bit faster than in previous months. The Fed and market players are more focused on potential inflation these days.

PPI Consensus Forecast for Nov 04: 0.1 percent
Range: -0.4 to 0.3 percent

PPI ex food & energy Consensus Forecast for Nov 04: 0.2 percent
Range: 0.1 to 0.3 percent

The University of Michigan's consumer sentiment index edged up to 92.8 in November, although the Conference Board's consumer confidence index ended up falling in the month. Market players will be interested to see whether confidence has improved as we approach the holidays.

Consumer sentiment index Consensus Forecast for mid-Dec 04: 93.5
Range: 90 to 97

The U.S. Treasury reported a budget deficit of $57.3 billion in October, the first month of fiscal year 2005. Typically, November also sees a deficit for the month, sporting an average deficit of $35.5 billion over the past ten years.