• Strong. Recession in residential construction, bankruptcies of mortgage lenders and an ongoing crisis at the Big 3 automakers ??“ the US labor market appears to be defying all adversity. In March, 180k new jobs were created. At the same time, the unemployment rate fell to an extremely low 4.4%.
• Turnaround. The labor market??™s heyday is, however, over. Ultimately, it is considered a lagging economic indicator. Additional strains are coming from the slowdown in investment activity: Investment activity does not replace jobs, it creates jobs.
• Season. Furthermore, construction and real estate companies will not create any more new jobs. The gain in March was merely a technical reaction. Seasonal factors aggravate the problem. Normally, most jobs are created in the spring quarter. The markdowns for the seasonal adjustment are correspondingly high. For that reason alone, up to 300k jobs will be missing in the statistics over the next three months!
• Dilemma. That complicates the Fed??™s job even more. At the same time that the labor market is weakening in the future, inflationary pressure continues to build. The recent rise in import prices is a further warning signal. It is quite possible that the current decline in rate cut expectations will reverse again in spring. Ultimately, however, the Fed should hold its target rate steady this year.

Further topics:

• ECB: Press conference supports our expectation of further rate hikes.
• France: Election outcome uncertain, far-reaching reforms unlikely.
• Data outlook: ZEW growth expectations improve further; oil price increase drives US consumer prices higher.
• Market outlook: Stabilizing bond market, EUR-USD targeting its all-time high; ongoing carry trade boom a topic at the G-7 meeting.

MARCH EMPLOYMENT BURST MIGHT FIZZLE OUT IN SPRING

• The US labor market has been putting its best foot forward recently. The decline in the unemployment rate and the solid increase in employment in March led to a decline in rate cut expectations.
• However, the labor market might weaken again substantially over the next three months. One reason for this is the negative employment effect resulting from declining investment activity.
• Furthermore, construction companies will probably create substantially fewer jobs in spring than is normal for the season. That can put strong downward pressure on the seasonally-adjusted rise in payroll employment.
• The Fed is, therefore, still facing a dilemma. With weak economic indicators on the one hand and stubborn inflation data on the other, we continue to assume the Fed will hold its key rate steady in the current year.

GOOD NEWS FOR THE FED ON GOOD FRIDAY

The employment report released by the Bureau of Labor Statistics on Good Friday was in fact more than good ??“ at least for the Fed. The bond market, in contrast, eased further when it was announced that in March non-farm payroll employment in the US had increased by another 180k and the unemployment rate had fallen to 4.4%. Even the fact that the strong increase in employment in the construction sector (+56k) was merely a correction of the weather-related weakness in February (-61k) could not prevent rate cut expectations from declining.

The resilience of the US labor market has been a reliable constant for months. Even though the US economy has grown at rates below potential for three consecutive quarters, non-farm payrolls increased on average by a respectable 170k per month. The main reason why the end of the housing boom, the weakness in the auto industry, the problems facing mortgage lenders as well as the decline in capex orders have so far failed to weaken the labor market is the structural employment increase in some service sectors: Since spring 2006, most of the additional jobs have been created in sectors that have little to do with the business cycle; government and education & health services alone accounted for 40% of the increase in employment in the economy as a whole. Furthermore, almost no jobs have been eliminated so far in the cyclical goods-producing sector: Even though the number of gainfully employed in manufacturing has declined by just over 100k since the beginning of 2006 and 70k jobs were also eliminated in residential construction, at the same time approx. 230k jobs were created in non-residential construction (incl. civil engineering, cf. chart).

The support from structural employment gains looks set to continue for the time being. Above all in the healthcare sector, demand for medical services has been rising at an accelerated pace for months. Nevertheless, we assume the upcoming employment reports might be substantially weaker than the positive Good Friday report. This in turn will again increase the pressure on the Fed to ease.

SEASONAL FACTORS REQUIRE SUBSTANTIALLY MORE NEW JOBS IN CONSTRUCTION

But why should the labor market deteriorate now of all times? In spring, above all employment in weather-sensitive sectors such as construction should post a strong increase. The reason is that markets and economists focus on the seasonallyadjusted numbers ??“ and not on the original data. So even if employment (nsa) rises in one month, it can be that the more important seasonally-adjusted number shows a decline. This is always the case when the increase in one month is lower than is seasonally normal. Let??™s return to the construction sector. We have suspected that employment here will increase strongly at the beginning of spring. And the following chart does indeed show that the seasonal factors for employment in construction between March and August were consistently positive on average for the last 30 years. Since, therefore, employment in these months normally increases more strongly than the average for the year, a certain amount is deducted from the original data for the seasonal adjustment. And while the seasonal factor in March was still roughly 100k, in April ??“ the month for the next employment report ??“ it is already more than 200k. Overall, the seasonal correction factors for the months April to June total 570k. It is, therefore, by no means enough that more jobs are again created in the construction sector during the spring months. Merely to hold the rise in construction employment constant in seasonally- adjusted terms, more than half a million (!) additional jobs would have to be created in the coming three months. The JOLTS (Job Openings and Labor Turnover Statistics) show that most of the seasonal increase in employment between April and June normally takes the form of additional hiring ??“ and less of lower separations (cf. lower chart).

An increase in employment on this scale is currently difficult to imagine. Residential construction remains in a recession, and even non-residential construction already peaked at the middle of last year. While it is quite possible that construction companies will find it difficult to lay off employees because of labor law obligations, in contrast it appears more than doubtful that they will create additional jobs in the current situation. But exactly that would be necessary to hold the seasonallyadjusted rise in employment constant in the coming months.

NO JOBS WITHOUT INVESTMENT

Another factor that will probably hurt the US labor market is weaker business fixed investment. The following chart shows namely that capital (investments) and labor are by no means substitutes. Investments do not destroy jobs ??“ they create jobs. But companies' willingness to invest is declining steadily. After investment in equipment and software already declined in Q4 2006, the picture does not look much better in the first quarter of the current year. Shipments of non-defense capital goods in January and February, for example, were down a further 8??% (annualized) below the Q4 average. Only very strong activity in March can, therefore, prevent a renewed decline in investment in equipment and software in the first quarter.

The main reason why investment activity is declining so strongly, despite still booming corporate profits, is the deterioration in business expectations. Current investment decisions are namely determined less by the high profits of past quarters than by expectations for future earnings.1 The labor market will presumably also feel the effect of this in the coming months (cf. chart). While spillover effects from investment to employment generally require some time, investment in equipment & software has already been declining since the end of 2006. Hence, the first negative employment effects could already become visible in the course of Q2

STAGFLAT IONARY TRENDS STILL CAUSING PROBLEMS FOR THE FED

Weaker business fixed investment and the ongoing recession in the housing sector are, therefore, likely to become a more perceivable drag on the US labor market over the next few months. If hiring in the construction sector remains clearly below the normal level, this can already lower the seasonallyadjusted non-farm payroll figure in April by up to 100k.

The Fed??™s dilemma is, therefore, by no means resolved. Weak economic indicators on the one hand and stubborn inflation data on the other will also set the tone for US monetary policy in the coming months.2 Numerous speeches by Fed officials as well as the Minutes of the last FOMC meeting released on Wednesday have underscored once again that the Fed??™s primary focus ??“ its ???predominant concern??? ??“ in this context is still fighting inflation. Rate cuts are, therefore, only an option if the economy deteriorates much more dramatically in the coming months than assumed so far. We continue to assume that the Fed will stay on hold in the course of the year. Investors, in contrast, will intensify their rate cut expectations in coming months.