Payrolls Plummet, Odds of a Rate Cut Improve

By Jason Simpkins
Associate Editor

Payrolls fell for a second straight month, suggesting that a recession has taken root in the beleaguered U.S. economy and the Federal Reserve will have to take greater steps to increase liquidity and preserve growth despite rising inflationary pressures.

U.S. payrolls suffered their biggest monthly decline in five years in February, as employers shed 63,000 jobs, the Labor Department reported Friday. And 22,000 jobs were lost in January, revised up from the 17,000 originally reported. It was also revealed that only 41,000 jobs were created December, half the 82,000 first reported.

"This confirms the fears that have been lurking in the financial markets in recent weeks," Richard DeKaser, chief economist at National City Corp. (NCC), told Reuters. "The probability of recession is at more than 50%."

It's the first time payrolls have declined for two straight months since May and June of 2003. February's loss was the largest since March 2003. 

Manufacturing industries slashed 52,000 jobs, retail lost 34,000, and the construction business eliminated 39,000 jobs. Since the housing bubble peaked in September 2006, the construction industry has shed 331,000 jobs.

The only silver lining the labor report had to offer was the addition of 38,000 jobs to government payrolls, and an addition of 30,000 payrolls to education and health services.

Fed Action

Prior to the report's release, the Federal Reserve announced it would increase the amount of loans it offers to banks this month. The central bank will offer $50 billion in four-week funds to banks at its March 10 and March 24 auctions, up from $30 billion. It will also make $100 billion available through repurchase agreements.

This is the latest action by Fed Chairman Ben S. Bernanke to increase liquidity and help the financial sector overcome mounting losses from lending defaults.

"The amounts outstanding in the Term Auction Facility (TAF) will be increased to $100 billion," the Fed said in a statement. "The auctions on March 10 and March 24 each will be increased to $50 billion - an increase of $20 billion from the amounts that were announced for these auctions on February 29."

In addition to Bernanke's TAF tinkering, it is largely expected that the Federal Reserve will further reduce interest rates at its next meeting, March 18. The Fed Chair has repeatedly voiced concern about the current prospects for economic growth.

In a pessimistic analysis of the U.S. growth outlook, Bernanke said that the latest data "continues to suggest sluggish economic activity in the near term," while also asserting that inflation expectations are "reasonably well anchored."

Last week, several FOMC members reaffirmed Bernanke's position, saying the Fed ought to err on the side of doing too much, despite mounting concerns about inflation.

"Because credit contractions can emerge and spread rather quickly the central bank must be prepared to act in an aggressive and timely manner to counteract their effects," said Cleveland Federal Reserve President Sandra Pianalto. "Inflation expectations appear to be anchored."

Speaking to the Council on Foreign Relations in New York, Federal Reserve Bank of New York President Timothy Geithner, said: "If turbulent financial conditions and the associated downside risks to growth persist, monetary policy may have to remain accommodative for some time."

Analysts anticipate a reduction of 50 to 100 basis points in the benchmark lending rate. Futures have priced in a .75-point reduction, which would lower the rate to 2.25%.

However, not everyone is convinced that inflationary pressures remain as "well-anchored" as the Fed asserts. The question of whether the economy is entering into a period of stagflation has also arisen.

"I am disappointed," Michael Woolfolk, currency strategist at the Bank of New York Mellon (BK) told Reuters. "Bernanke had an opportunity to manage expectations on inflation and failed to take the challenge at his congressional testimony last week. He is rapidly losing the inflation-fighting credentials he won last year."

The producer price index was the last of three major Labor Department reports on January's inflation rates, which revealed that producer prices jumped by 1% for the month, more than double the increase analysts expected. The first two indicators, the consumer price index and import prices were equally dismal. Consumer prices rose 0.4% in January, while import prices increased 1.7%.

St. Louis Federal Reserve President William Poole is disappointed as well, after a speech at the University of Illinois, he told reporters Thursday that "insurance against recession is not free."

"We have to have a balance (between) employment and financial risks with inflation risks," he said.

The dollar hit a three-year low against the yen Friday, dropping to a value of 101.82 yen, the lowest since January 2005. The greenback also experienced its fourth consecutive weekly decline against the euro, touching $1.543 per euro Friday, its lowest mark ever.

"We've seen a huge shift in the market's thinking," toward the dollar, Simon Derrick, head of currency strategy at Bank of New York Mellon Corp., told Bloomberg. "The Fed in particular looks as though it's going to keep cutting and cutting rates. We could very quickly test $1.55."

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