Employment situation improving
Nonfarm payroll employment fell 89,000 in January, less than declines of the past several months. The three-month moving average of nonfarm payroll changes suggests payroll declines hit bottom though actual increases have yet to appear. Even factory payrolls are starting to post more moderate declines - the likewise 89,000 drop in manufacturing employment was the smallest monthly decrease since last September. Construction payrolls fell in January but these were offset by gains in the service-producing sector. One could point to special factors here and there among the components, but the bottom line is that they offset each other. The headline number in this case pretty much represents the state of the labor market - still sluggish but improving.

To everyone's surprise the civilian unemployment rate dipped to 5.6 percent in January, a 0.2 percentage point decrease from December and in contrast to expectations for an increase. The unemployment rate is a lagging indicator of activity and tends to rise into the early stages of a recovery. In fact, the lower unemployment rate may be a fluke. It turns out that the labor force decreased by nearly one million in January. If individuals aren't out looking for work, they're not considered unemployed. Consequently, with a drop in the labor force larger than a decline in employment, the jobless rate turned down during the month. Don't be surprised if the jobless rate ticks up again in the next few months.

Wages continue to show signs of moderation. Average hourly earnings were unchanged in January leading to a 4 percent yearly gain for the second straight month. Notice that yearly changes in hourly earnings peaked five months ago.

A more accurate depiction of employment costs, monitored closely by Fed officials, was reported for the fourth quarter. The employment cost index rose 0.9 percent in December and was up 4.1 percent from a year ago. Wages and salaries only increased 0.8 percent in the October-to-December period, but benefit costs jumped 1.2 percent. In the 12 months ended December, wages and salaries increased 3.7 percent and benefit costs gained 5.2 percent. The total ECI rise along with that for wages and salaries was either on par or less than the 2000 increase, but benefit costs accelerated again in 2001. Though weaker labor market conditions in 2002 could help dampen the overall gain in wages and salaries, benefit costs are determined largely by health insurance. Medical care and health insurance costs had moderated in the mid-90s but started to creep up again after 1997.

GDP surprise
The market consensus was focused on a drop of more than 1 percent in fourth quarter real GDP. The Commerce Department's advance estimate for the October--to-December period showed that real GDP inched up at a 0.2 percent rate boosted primarily by a surge in personal consumption expenditures and government spending. Consumer spending was concentrated among durable goods - motor vehicle sales. The strong incentives offered by automakers likely borrowed from future sales. This sector will likely be more subdued in the first quarter.

The Commerce Department doesn't have complete information in its first GDP release of any given quarter and must make estimates for such components as inventories, net exports, and capital spending. Both inventories and net exports played a major role in depressing GDP levels in the fourth quarter. However, an inventory liquidation of the magnitude we saw in the fourth quarter certainly can set the stage for production gains in upcoming months, particularly when it is accompanied by an increase in final sales. The 3.6 percent gain in final sales should be viewed with caution since it also incorporates strong gains in government spending.

Historically, economic recovery gets its spurt from increases in interest-rate sensitive sectors such as durable goods and housing, but this will likely not be the case in 2002 even if consumer confidence continues to rise as it did in January. However, the strong pattern of inventory liquidation over the past several quarters does suggest that inventory levels are lean. Only a slight pickup in demand will be sufficient to boost production and start inventory rebuilding.

On the whole, the GDP report showed that conditions weren't dire in the fourth quarter, but some of the gains in consumer and government expenditures may not be repeated to such a degree in the first quarter. These figures are consistent with the view that the economy is bottoming out, but aren't necessarily indicative of a rapid resurgence.

Manufacturing recovery?
New orders for durable goods rose 2 percent in December, reversing only one-third of November's 6 percent drop. However, several of the components (fabricated metals, machinery, computers and electronics, transportation equipment) have posted gains for the past couple of months. As a result, total new orders posted their first rise in the fourth quarter since the second quarter of 2000! New orders for nondefense capital goods declined in the fourth quarter, but posted the smallest quarterly drop in a year! It does appear that manufacturing may be turning the corner.

Early January data also showed continued signs of improvement. The ISM manufacturing index (formerly the NAPM Survey) increased to 49.9 percent during the month, just a tick shy of the 50 percent level that correlates to growth in the industry. As it was, the improvement over the past few months is still significant. Three key components of the ISM index were well above 50 percent: new orders, production, and supplier deliveries. New export orders and import orders also posted levels above the 50 percent mark. Barring any shocks to the economy, the trend would suggest that the ISM index could very well hit or surpass 50 percent in February.

Construction in the doldrums
Construction expenditures edged up 0.2 percent in December after an equally meager 0.3 percent rise in November. The two monthly gains were enough to push the fourth quarter into positive territory. Total construction expenditures increased at a 1.9 percent pace, boosted by gains in the residential sector. Nonresidential construction expenditures plunged at an 18.6 percent rate, accelerating from the hefty declines posted in the two previous quarters. The outlook for the nonresidential sector may not be promising in the near term as office building vacancy rates are rising.