Initial jobless claims dropped 20,000 to 321,000 during the week ended April 21. The four weekmoving average at 332,000 shows an upward trend that is clearly indicative of sluggish demand for labor.

Continuing claims, which lag initial claims by one week, rose 65,000 to 2.594 million. The insured unemployment rate was up one notch to 2.0%. The underlying trend of continuing claims also suggests soft labor market conditions. The message from this report runs counter to remarks in the latest Beige Book which pointed to tight labor markets in several Districts.

Labor Compensation Being Watched

The Employment Cost Index (ECI) rose 3.3% on a year-to-year basis in the fourth quarter of 2006, matching the gain posted in the prior quarter. The ECI has shown a small amount of acceleration from the beginning of 2006 when it rose 2.8%. By contrast, hourly earnings have increased more rapidly. Hourly earnings advanced from a 3.45% year-to-year gain in the first quarter of 2006 to 4.12% in the fourth quarter of 2006. The fourth quarter reading appears to be a peak for hourly earnings because in the first quarter hourly earnings rose at a less rapid pace of 4.06% from a year ago. The latest Beige Book reported modest wage gains in several Districts. The FOMC??™s hawkish stance may be reinforced if the ECI shows further acceleration in the first quarter. The market is looking for a 0.9% increase in the first quarter, which translates to a roughly 3.6% gain on a year-to-year basis.

Japan: Tomorrow??™s Indicators Offer A Look At Past Stability, Future Rate Hikes

As April 30 is a national holiday in Japan, tomorrow is the last business day of April and therefore loaded with end-month economic indicator releases. Along with unemployment and job availability data for March, there will be reports on March housing starts, construction orders, industrial production, consumer prices and retail sales, along with the April PMI for manufacturers. And to top off an already busy day, the Bank of Japan (BoJ) is holding its policy meeting and releasing its latest Economic Outlook report. Tokyo analysts will have their hands full indeed.

In viewing the consensus estimates for all of tomorrow??™s indicators as a whole, it appears that the market sees the Japanese economy as still stable with a fair tailwind. The consensus suggests that economic weak patches remain at the consumer level, where retail sales have still failed to catch fire, and the specter of deflation is still hovering about since the consensus has the year-over-year change in CPI again retreating into negative territory for March. Under this scenario, the BoJ is expected to keep interest rates on hold due to its concerns about deflation, and just let the economy continue to grow with an overnight call rate at 0.5%. While we have no complaint about the consensus view of the economy, we feel that what the BoJ will do (steady rates) is not what the BoJ should do (more aggressive tightening), and that there is only a limited opportunity for the central bank to pursue its goal of ???normalizing??™ the interest rate environment.

While the BoJ is worried about extinguishing growth, we would like to point out that almost two years have passed since the central bank??™s July 2005 announcement that it would be removing liquidity as a first step toward raising interest rates. Not surprisingly, when liquidity started getting mopped up, money supply growth as reflected by M2 slowed down in both nominal and real terms, and the economic growth outlook weakened as well. When the overnight rate was hiked in July 2006, money supply growth was shaking off the effects of the 2005 mop-up, and M2 growth started to rise from the doldrums. As of February, real M2 growth was at 1.3% and on the rise ??“ quickly approaching the healthier levels witnessed pre-2005.

Real money supply tends to be a good leading indicator for growth, so this rebound suggests that for the next few quarters, the Japanese economy will be on solid footing ??“ which brings us back to the main point. The BoJ knows that monetary conditions are still soft, but does not want any tightening to be economically disruptive. In the near-term, we feel that there is an opportunity for a 25 basis point rate hike this quarter, and perhaps for Q3 and Q4 as well. However, our forecast suggests that the BoJ will not actually take action until Q3 at the earliest, and perhaps not until Q4 if political pressures remain high. This would be unfortunate, since forecasters are suggesting that the global economy will be slowing down in 2008, and the major economies will be in easing modes by then. We can only hope that Japan is prepared.