WEEKLY ECONOMIC COMMENTARY - WEEK OF FEBRUARY 10,2012

This time it's for keeps. That's what kids say when they really, really mean it. For sure, there are few kids among economic professionals who earn their living by forecasting the direction of the economy. But this time they seem to really, really mean it when they say that the economy is gaining momentum and heading for a self-sustaining expansion. Of course, they really, really meant it back in early 2010 and 2011 when they asserted much the same thing, only to wind up embarrassed when events didn't exactly go their way. Are they setting themselves up for another round of disappointing results? Or is the recovery this time for keeps?

Time will tell, as usual, but there is little question that a more optimistic sentiment has once again taken hold in the forecasting community. True, hardly anyone is predicting a blockbuster upturn this year. Certainly not the administration, which remains on the defensive following three years of underperformance relative to expectations and what now seems like bold predictions made by the president at the start of his four-year term. But even the president and his advisors are starting to feel more upbeat - and for good reason. Granted, the target of a 6 percent unemployment rate is out of reach; but that lofty goal was made before anyone realized how deep the recession would turn out to be, which drove the jobless rate to far higher levels than expected. While many reputable political analysts believe that the rate remains too elevated to salvage the president's election prospects this November, others believe that the direction underway will be just as important in swaying the voters.

If the latter is the case, Obama has reason to cheer. With last week's report showing a drop in the national unemployment rate to 8.3 percent in January, the downward movement from its nearby peak of 9.1 percent seen in August has been an eye-opener. Indeed, the 0.8 percentage point drop ranks among the steepest declines for a five-month period observed during postwar recoveries. Still, the labor market appeared to crank up twice before during the current recovery, only to fizzle out as the economy stalled. The latest example was just over a year ago, when the rate plunged by an even larger 0.9 percent between November 2010 and March 2011 and then stagnated over the next seven months. If that pattern repeats in coming months, the administration's hopes will no doubt be deflated again. However, there are positive signs pointing to continued progress as the year unfolds.

For one, the latest drop in the unemployment rate occurred for the right reason. For the most part, the erratic drop from the cyclical peak of 10 percent in October 2009 reflected as much a shrinking of the labor force as an increase in job creation. That led many skeptics to believe the statistical drop in the jobless rate was more an illusion than a fact. After all, if someone drops out of the labor force, he or she is no longer counted as unemployed. Between October 2008 and the end of last year, the size of the labor force fell by roundly 1 million workers, even as the population grew by more than six million. That discrepancy resulted in an ever-larger pool of folks outside of the labor market, notwithstanding the drop in the unemployment rate. But January's rate decline occurred despite a huge 508 thousand increase in the labor force. For once, companies expanded payrolls at an even faster rate.

To be sure, one-month does not make a trend and the labor force has a tendency to show wide gyrations from month to month. But if we keep an eye on the most important determinant of unemployment, the demand for workers by companies, things are looking much better than was the case a year ago. According to the latest figures issued by the Labor Department, the number of job openings surged in December, the latest month available. During the month, companies posted 3.37 million job openings, the highest since August 2008 and up from 3.12 million in November. As the chart shows, the trend has been decidedly upward since last spring, albeit in a jagged fashion. Likewise, the number of quits - a sign that workers are feeling more confident in job prospects elsewhere - has also been trending higher.

Unfortunately, actual hiring has not kept pace with the increase in job openings. Indeed, new hires actually fell in December, reversing most of the previous month's increase. There is no simple explanation for this lag. It may be that companies are having a hard time finding workers with the right skills needed for the jobs they want filled. A decline in labor mobility may also be a factor. The depressed housing market has kept many families stuck in hard-to-sell homes, preventing them from moving to where the jobs are. That said, it usually takes between 1-3 months for a company to fill a job listing. Assuming past patterns hold, the surge in job openings in December may largely explain the stronger-than-expected increase in net job creation in January reported last week. What's more, it may well portend another upside surprise in job growth in February assuming, of course, that the job openings surge in December holds up.

Another way of gauging the improvement in job prospects is to compare the number of job openings with the number of people seeking jobs. Many view this comparison as a barometer of the slack in the labor force. In December, there were 3.88 unemployed workers for every job opening, down from 4.27 in November. As can be seen in the chart, it's the first time this ratio has dipped below 4 since December 2008, and the latest month is well under the 6.93 high reached during the recession trough in July 2009. Simply put, some slack in the labor force has been taken up, which suggests that workers may soon be in a better bargaining position to obtain bigger pay raises. Still, there is a long way to go before a healthy balance between demand and supply of workers is established. A more normal ratio, representing a healthy job market, is one in which the ratio of job openings to unemployed workers is under 2. It will be a while before that threshold is reached.

One other portent of stronger hiring in coming months is simply that companies have squeezed as much output out of the existing workforce as possible. In the first quarter of 2010, nonfarm productivity surged to 6.2 percent compared to a year earlier, the highest since the fourth quarter of 1961 - nearly fifty years - following a robust annual increase of 5.3 percent in the previous quarter. Since then, however, it has been all downhill. By the fourth quarter of 2011, the year-over-year growth rate in nonfarm productivity slowed to a miniscule 0.5 percent. Needless to say, companies will have a hard time meeting demand by boosting productivity in the quarters ahead. For job seekers, that's good news as it offers hope that the latest surge in job openings is a manifestation of the growing need for labor.

So the pillars for an improving labor market would seem to be in place. The only question is, will the demand needed to sustain the recent strength in job creation remain firm. This is where the rubber meets the road, and where many skeptics believe is the Achilles heel of the recovery. Clearly, the retrenchment of consumer spending after sporadic bursts in both 2010 and 2011 played a major role in stalling out the nascent pickup in job growth during those years. Keep in mind though that households were firmly in the grip of a deleveraging process, paring debt that was aggressively acquired during the housing bubble years and required an outsize fraction of income to service. With debt repayments came spending restraint, particularly since real incomes were virtually stagnant during the period. The Federal Reserve, of course, exerted heroic efforts to stem the deleveraging tide, pushing interest rates down to rock-bottom levels, hoping to get consumers spending again.

In hindsight, those efforts were not successful, as households shunned debt-fueled spending in favor of restoring healthy balance sheets. This is a certainly a beneficial long-run development that even the Fed acknowledges, but it hampers the recovery in the short-run. That's especially the case when it is reinforced by fiscal austerity from federal as well as state and local governments, which has clearly been underway in recent years. However, the fruitless quest by the Fed to encourage consumers to borrow again may finally be bearing results. In the most recent two months, consumers have taken on an astonishing amount of new debt - to purchase autos, finance education and even to add balances to credit cards. In November and December, consumer credit jumped by a whopping $40 billion, the largest two-month increase in more than a decade.

To be sure, the latest borrowing binge has generated mixed feelings among analysts. Some believe that it is a temporary fluke related to holiday shopping and a desperate attempt to make ends meet until incomes can catch up. That may well be the case, particularly since the December borrowing surge seems inconsistent with the unchanged spending pattern seen during the month. But that's the half-empty view. Those who see consumer behavior through a half-full glass note that the borrowing upsurge was accompanied by a similar eye-opening increase in consumer confidence. Throw in the surprisingly strong employment numbers, and a case can be made that households are feeling better about prospects and are willing to take on more debt to satisfy pent-up demand for cars and other discretionary items.

So the question remains, is this recovery for keeps? Certainly, the internal dynamics are looking good - better job growth begets more income and confidence, leading to stronger demand that feeds back into more hiring. But the loop can easily be disrupted again by events beyond our control, such as another financial upheaval related to the never-ending European debt crisis, a spike in oil prices or an escalation of tensions in the Middle East with Iran at the center. Then there is the threat of a homegrown disturbance associated with ongoing squabbling in Washington during an election year. We remain hopeful that a deal can be forged in extending the payroll tax cut and long-term unemployment benefits, but time is running short as Congress goes on holiday recess at the end of next week. It looks like a permanent fix is not in the offing before then, but the odds favor at least a temporary extension that would avoid a confidence-shattering event. We hear that a bill with the ungainly moniker "The Temporary Payroll Tax Cut Continuation Act" is in the hopper for consideration next week. Stay tuned.