Along with ice and snow, this week brought with it the first reports of US economic activity in 2011. Most of the news was good, but employment data remained, as Churchill once said of Russia, “a riddle wrapped in a mystery inside an enigma.” Growth in the US services and manufacturing sectors accelerated in January, significantly surpassing consensus expectations. The manufacturing sector, which has spearheaded the recovery, grew at its fastest pace in nearly seven years, outpacing even the highest estimate in Bloomberg’s survey. While manufacturing has lead the recovery, it only accounts for 10-12% of the US economy. As such, the acceleration of growth in the services sector was very encouraging. The services sector expanded in January at the fastest pace in more than five years. Additionally, auto sales in January were stronger than expected. The industry delivered an annualized, seasonally adjusted 12.6 million vehicles during the month, matching the highest level since the end of the government’s “cash for clunkers” program.
Despite the expansion in the services and manufacturing sectors, the employment report released this morning was somewhat of a mystery. For the third consecutive month payroll gains failed to meet consensus expectations, yet the unemployment rate fell for the second consecutive month. The economy added a paltry 36,000 jobs in January, well below the 146,000 expected, but the unemployment rate declined from 9.4% in December to 9%. Certainly some of the decline in the unemployment rate is due to a decline in the labor participation rate, which fell from 64.5% in November to 64.2% in January. However, this, and a modest upward revision of 40,000 jobs to November and December’s data does not fully explain the decline in the unemployment rate.
The conflicting data is largely the result of estimate errors and winter storms. The Labor Department estimates that weather prevented 707,000 Americans from getting to work during the week the employment survey was conducted compared with an average of 282,000 over the last five Januarys. Assessing the impact of severe weather on employment data is difficult. Not only does weather affect the employment survey, but it impacts the filing of new claims as well. Additionally, we note that monthly employment reports consistently experience significant revisions and January’s numbers will be revised in February and again in March. When one considers the acceleration in growth in the services and manufacturing sectors, it is likely that the overall impact of weather and estimate errors will result in a significant increase in the number of jobs gained in January once estimates are revised. While we would not be surprised to see revisions push January’s employment gains north of 100,000 jobs that would still be well below the consensus estimate of 146,000 and far below the level needed to meaningfully reduce the unemployment rate. Additionally, this month’s report also included the Labor Department’s revision to seasonally-adjusted data from January 2006 onward. The revisions resulted in the loss of an additional 300,000 jobs between 2008 and 2009 and a decline in the number of jobs created in 2010 of 215,000.
The manufacturing and services industries are growing robustly and corporate earnings have rebounded dramatically. Despite this, corporations, having learned during the recession that they can do more with less, remain hesitant to hire. Yet the labor market has clearly bottomed and we believe that hiring is likely to pick up as economic growth accelerates from the soft patch endured in the 2nd and 3rd quarters of 2010. However, a large portion of the unemployed have been out of work an extended period of time. As employers begin to add employees they are most likely to hire from the pool of applicants that are new entrants into the workforce or from the more recently unemployed. Therefore, it seems likely that the structural rate of unemployment is likely to be higher for years to come than it has been over the last 10-15 years.