Take jobs report with a grain of salt

INDICATOR: December Employment Report

KEY DATA: Payrolls: +74,000; Private: 87,000; Unemployment Rate: 6.7% (down 0.3 percentage point)

IN A NUTSHELL: "When weather and an odd calendar combine, it's best to take some of the economic data with a grain of salt and that is the way we should look at the December jobs report."

WHAT IT MEANS: Sometimes the data are just strange and the December employment report may be one of those reports. Both the payroll gains and unemployment rate came in nowhere near what seems to be the actual state of the economy. First, the unemployment rate fell sharply for the second consecutive month and hit its lowest level in over five years. That's great but the labor force and the labor force participation rate declined as well. More than likely, there will be those who only look at the participation rate and decide that the decline in the unemployment rate is artificial. But the details tell a different story. Over the year (the data are not seasonally adjusted), the number of people not in the labor force rose by 2.9 million. But the number of discouraged workers and people who want a job were both down sharply. In other words, it isn't the economy that is driving people out of the workforce, at least that is what the data indicate. There are two major trends at work, demographics - the aging of the labor force - and the ending of long-term unemployment payments. Long-term unemployment payments have likely caused an overestimation of the unemployment rate by keeping people in the labor force longer than normal. As those people leave the workforce, the rate will come down, possibly sharply. Weather also could have made a difference as some people simply could look for work. The cold and snow did have an impact on the numbers and we see it in the construction and transportation payroll declines. But there were also the usual oddities in the report. Maybe for the first time in the history of the world, the number of health care workers dropped. There were large declines in the number of motion picture workers, accountants and lawyers. Hard to worry too much about those. And strangely, the number of local education workers plummeted again, despite the trend toward rehiring that is occurring. Hourly wages rose but the weather probably caused the decline in hours worked and weekly wages. That does not bode well for income.

MARKETS AND FED POLICY IMPLICATIONS: This report was the best of times and the worst of times at the same time. The January numbers could also be strange as I am not sure if BLS has an adjustment factor for the polar vortex. So who knows what the payroll data will look like. Also, new population estimates will be included so it is unclear what the unemployment rate will be. Nevertheless, there are implications of this report. The markets will likely look at the job gains and think the Fed will worry about the labor market. I don't agree. I think the unemployment rate is more important. The missing link in this recovery is strong income gains, which will not happen until labor shortages start appearing. The closer we get to full employment, the more wages should rise. If the members believe as I do that the decline in the labor force is more demographics and policy than frustration, they will see the rate as real. That means they will expect incomes and economic growth to start accelerating.