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The Reich Rally May Have Some Room To Run


Business Outlook

THE REICH RALLY MAY HAVE SOME ROOM TO RUN

Don't be surprised if you see Robert B. Reich on Feb. 3 with his mouth taped shut. That's the day before January's employment report is released.

The Labor Secretary's very accurate "educated guess" that December payrolls rose in the range of 160,000 to 200,000, blabbed a day before the official report on Jan. 7, sent bond-market players scurrying to cover positions taken on the expectation of a much larger gain. His remarks about one of the most market-sensitive pieces of government data had Wall Street wanting his head.

In retrospect, Reich's impropriety may have touched off a rally in the bond market that could have some running room. The yield on 30-year Treasury bonds dipped from 6.40% on Jan. 5 to 6.34% on Jan. 6--after Reich's "forecast"--and to 6.22% the next day, after the news that payrolls rose by only 183,000 in December. That increase was below the 215,000 average expectation and well under the 250,000-or-more gain that several analysts had their trading floors bracing for.

What's more important than Reich's faux pas, however, is what the December employment report says about economic growth and inflation. Currently, bond prices almost completely reflect the very strong fourth-quarter growth in real gross domestic product, to be reported on Jan. 28. The job numbers don't dispute that.

But what has dogged the bond market in recent weeks is fear that rapid growth might continue in early 1994, thus fueling price pressures and the likelihood of a hike in short-term interest rates by the Federal Reserve. To date, these concerns have pushed long-term rates up considerably from their historic lows of less than 5.8% plumbed in October (chart).

The job data, however, allay some of the bond market's worries that stronger numbers would have fueled. The December report is consistent with the economy's current underlying growth rate of about 3%. It suggests that, after a robust showing for fourth-quarter GDP, expected to be in the range of 4% to 5%, first-quarter growth will slow to a more moderate pace. If so, the bond market may allow long-term rates to drift lower.

The latest inflation signals from the producer price index only reinforce the message from the employment report. The PPI for finished goods fell 0.1% in December, pulled down by a 3.5% drop in energy prices. Excluding energy and food, the core PPI rose 0.2%. In response to the news, bond yields fell further, to 6.18%, on Jan. 12.

Cheaper energy reflects the drop in crude-oil prices from $19 a barrel in October to less than $15 in mid-January. And given that OPEC cannot coax noncartel countries to cut output, and given the reports that OPEC will not hold an emergency session before the next scheduled meeting, in March, oil prices are likely to stay down.

For the year, producer-price inflation ended up a mere 0.4%, measured from December, 1992, with core inflation at only 0.3%. Further back in the production process, commodity prices are rising, as would be expected, considering the pickup in manufacturing and housing. But the rise has not been steep enough to suggest inflationary pressures are building under finished-goods prices.

Another good sign for inflation: The December employment report reflected the apparent continuation of better productivity growth. That pattern was especially evident in manufacturing, where employment rose a scant 2,000, while the factory workweek held at a record 41.7 hours. During the past year, factory output has risen by more than 5%, while jobs have fallen by 1%.

Still, manufacturers will likely add jobs in 1994. The National Association of Manufacturers forecasts 200,000 more slots this year, although some members are less optimistic. The December gain in factory employment was slim, but it did mark the third rise in a row, the first such string in five years.

As was true through most of 1993, nearly all of the new December jobs were in the service sector. Service payrolls rose by 173,000, led by gains in restaurants, temporary-help services, health care, and finance.

Despite the growth in service employment, the jobless rate in services, at 6.2% in December, remains little changed from six months ago (chart). The reason is that most unemployed people are searching in the service sector, where chances of landing a job are better.

In addition, the Labor Dept.'s attempt to remove the gender bias in its survey methods may already be causing some updrift in service unemployment, where such bias is likely to be the greatest. The new procedures, which are expected to lift total joblessness by about 0.4%, will be fully incorporated into the January survey.

The upshot: The bond market, in its never-ending search for price pressures, found none in the December employment report. Of course, it is always casting for clues. The worry is that a repeat of the fourth quarter's buying surge would make price increases easier to pass along. And bigger wage gains mean higher costs.

As the job data imply, however, this economy no longer reacts in such straightforward ways. Demand is picking up, but the economy is still growing at less than its potential. Productivity gains are covering most of the pay raises, so wage gains need not be inflationary.

The good news for the outlook is that incomes are growing fast enough to keep consumers in a shopping mood but not too fast to fuel inflation. The average hourly wage rose by 0.2% in December, to $10.95 an hour. At the same time, weekly earnings also increased 0.2% in December, the third consecutive gain. Coupled with the job additions, the rise in pay suggests another advance in personal income last month.

For the quarter, weekly paychecks grew at a 4.2% annual rate--the fastest quarterly clip in 2 1/2 years (chart). Heading into 1994, that extra pay means consumer spending will not falter this quarter. In fact, the Johnson Redbook Report said sales at discount and department stores in the first week of January were up 5% from their December average.

In addition to having more money in their wallets, households are also tapping into credit lines again, and that should help to lift spending further. Installment credit jumped by $6.9 billion in November, on top of a $7.7 billion surge in October (chart).

The borrowing binge continued in December. MasterCard International Inc. says that use of its credit cards soared 23.6% during the holiday shopping season, compared with the 1992 period. The biggest weekly rise came in the last-minute rush before Christmas.

Increased use of credit is in line with the recent splurge on durable goods, because big-ticket items such as cars, refrigerators, and dining-room sets tend to be financed. The strong rise in weekly pay suggests households had the cash to buy many of these goods. But credit-card incentives such as frequent-flier miles and the 0% financing offered by some retailers probably contributed to making plastic a better deal.

Consumers are adding as much to their installment debt now as they did in the mid-1980s. But there's a big difference: Unlike the '80s, today's borrowings are not outpacing income. Installment debt as a percentage of disposable income stood at 16.3% in November, the same ratio as at the beginning of 1993. Moreover, bankruptcies and loan delinquencies are down, suggesting that fewer households are under financial duress.

Certainly, last year's plunge in long rates helped to nourish consumer budgets, especially through mortgage refinancings. And low rates provide a boost to capital spending and housing, which pave the way for further job gains. That's why the economy would benefit from a continuation of the Reich rally--whether or not the Labor Secretary makes any more forecasts.JAMES C. COOPER AND KATHLEEN MADIGAN


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