Today’s Employment Situation showed a lackluster gain of 36 thousand in payroll employment that was well below the consensus estimate, a huge increase in household employment (after adjusting for January’s population controls), a surprising and large drop in the unemployment rate (from 9.4% to 9.0%), and a slight dip in the labor force participation rate. It also included benchmark revisions. What does it all mean?

• Bad weather probably restrained January’s rise in payroll employment by roughly 80 thousand. This will be reversed next month unless there is more bad weather.

• Newly applied population controls distorted January’s numbers for changes in population, employment, and the labor force, but not the levels of the unemployment rate or the participation rate. Allowing for the controls, civilian employment surged 589 thousand.

• Part of the surprising decline in unemployment is likely to be reversed. Still, the unemployment rate is well below our forecast of only a month ago, suggesting an upward revision — albeit only a small one — to our forecast of inflation.

• With unemployment lower and falling faster than expected, and the forecast for inflation thus subject to upward revision, our call that the Fed’s exit from its near-zero interest rate policy will be “early,” specifically at the first FOMC meeting in 2012, is reinforced.

• As expected, benchmark revisions to employment and hours were downward but not by enough to alter our estimates of trend growth much, if at all.

WEATHER EFFECTS
We estimate that adverse weather suppressed January’s rise in employment by roughly 80 thousand, and expect a reversal of this magnitude in February unless there is more unusually bad weather. To arrive at this estimate we take from the Household Survey the number of persons not at work due to bad weather (which surged from 196 thousand in December to 916 thousand in January), scale it by civilian employment, seasonally adjust that, and then include its change in a time-series model for the monthly change in establishment employment. This methodology suggests that bad weather may have reduced the change in establishment employment by about 80 thousand in January (with a 1-standard error range of roughly 40 thousand to 120 thousand). Note that the ADP estimate of the change in private payroll employment for January (which was 187 thousand) is not significantly affected by weather because the ADP data capture people on payrolls even if they cannot actually make it to work.

POPULATION CONTROLS
Annual population controls had little, if any, effect on either the reported unemployment or participation rates, but to the extent there may have been such effects they will not be reversed. In contrast, the new population controls contributed to changes in population, the labor force, and employment in January that muddied the interpretation of these numbers. However, after adjusting for the effects of the controls, the report showed a typical rise in population, no change in the labor force, and a huge increase in civilian employment of 589 thousand.

EMPLOYMENT CROSS CURRENTS
Growth of establishment employment the last two months has been somewhat disappointing, growth of employment in the household survey has been stunningly strong, and growth of payroll employment as measured in the ADP National Employment Report has been in-between but above expectations. It really is hard to know what to make of this, but we do have a sense that payroll employment has sometimes lagged household employment during recoveries, only to be revised up subsequently. In addition, we do suspect that January’s number was restrained by bad weather. Hence, we do not want to over-react to it. Therefore, except for the reversal of January’s weather effects, we will not change our projection of employment growth much as a result of today’s figures.

THE UNEMPLOYMENT RATE / INFLATION
In contrast to disappointing employment growth, the unemployment rate declined sharply and unexpectedly from 9.4% in December to 9.0% in January, and has fallen 0.8 percentage point over the last two months. We believe this is running a little ahead of the game. As we work to complete our forecast, we will assume a partial reversal of January’s decline, so that our final print likely will show an average unemployment rate in the first quarter of 9.1% or 9.2%. Nevertheless, this is almost ¾ percentage point lower than the 9.8% we showed last month. Given the role of labor-market slack in our model for core inflation, this argues for an upward revision to our inflation forecast of a tenth or two over the short-run forecast

MONETARY POLICY IMPLICATIONS
With unemployment lower and falling faster than expected, and the forecast for inflation thus subject to upward revision, our call that the Fed’s exit from its near-zero interest rate policy will be “early,” specifically at the first FOMC meeting in 2012, is reinforced.

BENCHMARK REVISIONS / TREND GROWTH
The report reflected the annual benchmarking of the establishment survey to the Quarterly Census of Employment and Wages (QCEW) for March of 2010. The revisions were downward by an amount that grew unevenly to 483 thousand (or 0.4%) by the end of 2010. As the BLS had already previewed these revisions, they were not a surprise.

These revisions will not be reflected in the official data on productivity and costs until the next official report out of the BLS in about 4 weeks. However, we can estimate fairly accurately that the growth of both productivity and hourly compensation will be revised up by roughly 0.2 percentage point per year over the last two years, with no impact on unit labor costs and hence no impact on inflation pressures from the cost side. Revisions to productivity of this magnitude are not likely to change our assessment of the economy’s trend rate of growth much, if at all, although our final assessment must await our processing of the official data in a few weeks.


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