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The January Jobs Report
February 6 – 10, 2012

Nonfarm payrolls rose more than expected last month and the unemployment rate fell further. The report wasn’t nearly as strong as it appears at first glance, but it was encouraging.

Recall that the Employment Report is composed of two separate surveys. The Household Survey, a telephone survey of 60,000 households, provides reasonably good estimates of ratios (labor force participation, the unemployment rate), but unreliable estimates of levels (the monthly number of employed individuals, for example). The Establishment Survey, which covers about 486,000 worksites, yields nonfarm payrolls, average weekly hours, and average hourly earnings.

Prior to seasonal adjustment, nonfarm payrolls fell by 2.689 million in January. Seasonal adjustment turned that into a 243,000 adjusted increase. In other words, we had fewer seasonal job losses than usual last month. Fewer jobs losses is a good thing, no doubt, but that’s not the same as job gains. The bigger test for the job market will come in the spring. Unadjusted payrolls typically ramp up from February to June.

Monthly Change in Nonfarm Payrolls, selected sectors (BLS):

	unadjusted	adjusted
nonfarm payrolls, th.	-2689	+243
private sector	-2211	+257
construction	-281	+21
manufacturing	-62	+50
wholesale trade	-51.9	+14.0
retail trade	-592.1	+10.5
finance	-65	-5
temp help	-236.4	+20.1
leisure & hospitality	-289	+44
federal government	-25	-6
state & local gov’t	-453	-8

The details of the Household Survey showed that 206,000 individuals were unable to work due to adverse weather during the survey week in January (the week that included the 12^th of the month). That compares to an average of 425,000 over the five previous Januarys. This figure is not directly comparable to the payroll data (which come from the Establishment Survey), but it gives you an idea of the impact from January’s mild weather.

The unemployment rate fell to 8.3% in January, down from 8.5% in December, 9.1% a year ago, and a cycle peak of 10.0% in October 2009. However, the employment/population ratio held steady at 58.5%, the same level as when the unemployment rate peaked. Labor force participation fell in January, and has accounted for much of the improvement in the unemployment rate over the last two years. Labor force participation was expected to ebb as the baby-boom generation aged, but that’s not what’s happening. Rather, the rate for those aged 55 and over is trending higher, likely reflecting the impact of lower home prices (since many had counted on their homes being their chief retirement asset). In contrast, participation rates for younger workers have declined. This is the tragedy of the last few years. Unemployed workers are losing valuable job skills and young workers are not getting the job skills they would normally acquire if the economy were near full employment. The soft job market has resulted in a loss of output (relative to potential) over the last few years, but there is significant heartache for millions of people.

Make no mistake. The labor market is improving and there’s hope for strong job growth this spring. Moreover, average weekly hours have been trending higher, consistent with an expected increase in new hiring in the months ahead. However, not to harsh your mellow, the January employment data were not as rosy as the headline figures would seem to suggest. These data should not change the picture for the Fed. We still have a lot of ground to make up in the labor market.

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The Fed: Dual Targets Or Dueling Targets?
January 30 – February 10, 2012

The Federal Reserve has adopted an inflation target, as many other central banks have done long ago. However, the Fed retained its dual mandate, with a soft employment target. How will the two goals be achieved and what happens when they conflict? The Fed says is will use a balanced approach.

The Fed lengthened the period for which it expects to keep short-term interest rates at exceptionally low levels (now, “at least through late 2014”). However, the five Fed governors and 12 district bank presidents have differing opinions on when the Fed should start raising short-term interest rates and what the appropriate level of the federal funds rate target will be at the end of 2014. There was closer agreement on where the federal funds rate target is expected to be over the long run (a 2% inflation rate + a 2.0-to-2.5% premium = 4.0-4.5%)

The Fed will now shoot for a 2.0% annual rate in the PCE Price Index, which is similar to the CPI, but adjusts for changing patterns of consumption. The 2.0% goal would allow for more effective monetary policy during recessions. Other inflation-targeting central banks have a similar goal. For the Fed, a 2.0% inflation rate is “price stability.”

The Fed also is required to achieve maximum sustainable employment, which “stands on an equal footing with price stability as an objective of monetary policy,” according to Fed Chairman Bernanke. The unemployment rate statistic is an imperfect measure. It excludes discouraged workers and underemployment. Improvement over the last year has been exaggerated. Moreover, the unemployment rate consistent with maximum sustainable employment may change over time or may not be directly measureable. The Fed’s second goal is a judgment call, and opinions vary. Officials believe the appropriate unemployment rate target is currently between 5.2% and 6.0% – higher than it was before the financial crisis.

What happens when the Fed’s two goals conflict or when one goal is near its target and the other is far from it goal? Would a balanced response imply that a higher inflation rate is acceptable in the short run to help push the unemployment rate down? That’s possible, but it’s not what the Fed is currently forecasting.

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The Inflation Outlook
January 23 – 27, 2012

The Consumer Price Index rose 3.0% in 2011 (December-to-December), twice the rate of 2010. A big part of that increase was food and energy prices, which picked up in the first half of the year. Ex-food & energy, the CPI rose 2.2%, not especially high. The shorter-term trend in the CPI is benign. The overall CPI fell at a 0.4% annual rate in the final three months of the year, while the core rose at a 1.8% pace.

Economists tend to focus on core inflation because we’re interested in the underlying trend – not because food and energy prices don’t matter. However, there are a variety of core inflation measures, including the median CPI, trimmed mean estimates, and my personal favorite, the stick price index (which measures inflation in prices that tend not to change very often). All of these measures rose in 2011, but from very low levels in 2010. The Fed’s chief inflation gauge is the core PCE Price Index, which, among these measures, fell the least in 2010 and rose the least in 2011. Recall that the PCE Price Index is similar to the CPI except that the weights shift as consumption patterns change over time (in the CPI, the weights are adjusted every five years). The PCE Price Index ex-food & energy rose 1.7% in the 12 months ending in November, which is smack in the middle of the Fed’s implicit comfort range of 1.5% to 2.0%.

When the Fed embarked on its second round of asset purchases in 2010, officials were worried about the threat of deflation. The 2011 inflation results suggest that the Fed was successful in warding off deflation, but inflation did not surge as some had feared. In 2010, Chairman Bernanke argued that real interest rates are what matter. For a given nominal interest rate, lower inflation raises the real interest rate – and higher real interest rates are less stimulative for the economy. One line of reasoning, not expressed by the Fed, but embraced by a number of private-sector economists, is that the Fed should shoot for a higher inflation target in the current environment, to push real interest rates even lower and further stimulate the economy. However, a short-term push for higher inflation could un-anchor inflation expectations. Nominal interest rates could rise, keeping real rates steady. More importantly, the Fed would risk losing its inflation-fighting credibility.

So where is inflation headed in 2012? The Fed views inflation as being driven by inflation expectations, which act as a form of inertia, and the amount of slack in the economy. Inflation expectations have remained relatively low. The spread between the 10-year TIPS yield and the regular 10-year Treasury yield has been trending at around 2.0% (this spread isn’t really the market’s expectation of inflation, but a rough approximation).

The economy is still operating with a large amount of slack. Inflation pressures could heat up if that slack were to disappear, but this should be a very gradual process. The labor market is the widest channel for inflation. In the oil price shocks of the 1970s and early 1980s, inflation quickly became embedded in the labor market. That hasn’t been the case more recently. Union membership was a lot higher in the 1970s and many unions had wage contracts tied to the Consumer Price Index. We’ve had a number of increases in oil prices over the last 10 years, but there’s been no sign that pressures have fed through to wages.

Higher oil prices, in recent years, tend to be associated with slower growth – a short-term burst of inflation, but not a higher inflation trend. Oil prices remain a significant wildcard for the growth outlook in 2012, but also for the inflation outlook.

Despite the moderate inflation results for 2011, some still believe the Fed’s accommodative policy will lead to a substantial increase in inflation sooner or later. However, we’re still a long way from a full economic recovery, and there will be plenty of time to unwind the Fed’s accommodation when appropriate.

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The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.

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