Jobless-Claim Surge Spooks Wall Street

A Labor Dept. report reveals a spike in first-time jobless claims for the week ended July 26

By BusinessWeek, Standard & Poor's, and Action Economics staff members

Wall Street, already jittery about what the Aug. 1 release of July's U.S. employment report might contain, got a shock from another key labor-market indicator on July 31: A Labor Dept. report showed a surge in first-time jobless claims for the week ended July 26. The news appeared to outweigh a report showing steady, if unspectacular, U.S. economic growth in the second quarter and a tame reading on labor-cost inflation, sending stock index futures sharply lower in premarket trading. However, an increase in a closely followed regional manufacturing survey later in the morning on July 31 appeared to take some of the sting out of the claims jump.

Looking more closely at the reports, U.S. initial jobless claims jumped 44,000, to 448,000, in the week ended July 26, from 404,000 the week before. The figure was much larger than the modest decline to 395,000 that markets expected, though the Labor Dept. attributed the pop to a recent legislative change, stating that "the jump in claims was due to special factors linked to the emergency unemployment program."

The four-week moving average rose to 393,000 from 382,000. Continuing claims surged 185,000, to 3,282,000 in the week ended July 19, bringing the insured unemployment rate to 2.5% from 2.3% the week before. The data are worse than expected, says S&P Economics.

A "W"-Shaped Recession

Real (adjusted for inflation) gross domestic product rose 1.9% in the second quarter, in line with expectations. The report includes revisions to the last three years, which slightly lower growth rates in 2007 (to 2.0% from 2.2%), 2006, and 2005. First-quarter growth was little revised (0.9% from 1.0%), but the 2007 fourth quarter was revised to minus 0.2% from plus 0.6%, making the downturn look much more like a "W"-shaped recession, according to S&P Economics.

Consumer spending rose 1.5% in the second quarter, a little less than expected, but nonresidential fixed investment was stronger (up 2.3%) and export volumes jumped 9.2%. "We believe the current strength is largely caused by the rebate checks, and that growth will turn negative when the checks run out in the fourth quarter," says S&P Economics.

"For the second quarter, the data were almost exactly as expected, but with weaker trends given revised data for service consumption and real equipment purchases, and massively weaker inventories than expected—with a jumbo $62.2 billion rate of inventory liquidation in the second quarter," wrote Action Economics analysts in a Web site posting. "[W]e still tentatively expect the Q3 GDP figures to reveal a similar 2.2% growth rate, with a lower consumption trajectory from services but more room for an inventory bounce in the third and fourth quarters."

Labor Cost Gains Are Restrained

Meanwhile, U.S. labor cost increases continued to be muted. The second-quarter employment cost index (ECI) rose 0.7%, the same as seen in the first quarter and in line with expectations. ECI increased 3.1% for the year ended June 2008, decelerating from the 3.3% pace reported in the first quarter. The wage component decelerated to a 0.7% rate from a 0.8% rate the quarter before, on less commission and bonus income. The benefit costs component held at a 0.6% rate. "Overall, the relatively tame inflation reading will give the Fed reason to stay on the sidelines until the recovery is firmly in place," says S&P Economics.

The Chicago purchasing managers' index (PMI) improved to 50.8 in July from 49.6 in June, logging the first reading above 50 since January's 51.5. The index was 58.7 a year ago. As for the components of the report, the employment index slipped to 45.9, vs. 46.7 in June. New orders rose to 53.5 from 52.0. Prices paid surged to 90.7 from 85.5.

The mix of data are bearish for bonds and should support the dollar, though there may be only marginal net impact as traders remain focused on the jobless claims and GDP data, according to Action Economics.

U.S. stocks, after plunging in premarket trading following the surge in initial jobless claims, turned mixed after the Chicago PMI report. Fed funds futures surged in tandem with Treasuries after the jump in jobless claims. The November Fed funds futures contract suggests only about a 60% risk for a Fed rate hike, from about a 72% chance previously, while the December contract reflects about a 68% chance, vs. 88% previously.