Jobs: Not slow enough

NEW YORK (CNNMoney.com) -- The last time the U.S. economy had job growth this weak, the Fed funds rate was only 2 percent, well under half its current level.

The economy created just 88,000 jobs last month, the government reported Friday, the weakest level since November 2004, back when the term "jobless recovery" was on everyone's lips.

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The unemployment rate also ticked higher in Friday's report to 4.5 percent from 4.4 percent, and the 12-month gain in hourly wage growth was at its weakest level in almost a year.

The report follows one a week ago that showed the slowest pace of economic growth in four years, coupled with soft auto sales in April and new reports almost daily about problems in the U.S. real estate and home building markets.

So as investors, economists and the Federal Reserve mull the latest reading on the U.S. labor market, the question on many minds on Wall Street is how weak does the job market have to get for the central bank policy-makers to start thinking about cutting rates?

The answer is probably quite a bit weaker.

It's almost a sure thing the Fed won't change its key short-term interest rate at Wednesday's meeting, and that's probably true no matter how strong or weak Friday's job number turned out. And most economists say there will have to be sustained job market weakness for the Fed to even consider cutting rates - because the central bankers are still worried about pricing pressures.

"All measures of inflation are slightly above Fed comfort level," said John Norris, the chief economist and senior fund manager at Morgan Asset Management. "I think the Fed would like to not make a change to monetary policy this year. If we start seeing unemployment approaching 5 percent and the jobs number comes in consistently weaker than expected, then maybe the Fed has to take a look at it."

Norris and some other economists noted that some recent reports such as factory orders and a key survey of manufacturing executives have shown surprising strength amid other indicators of economic weakness.

Those numbers suggest the Fed won't even call attention to economic weakness outside of housing in its closely read statement to be released at the end of Wednesday's meeting.

"I think they're happy with the way things are," said Nasri Toutoungi, a fixed income portfolio manager for Hartford Investment Management.

Toutoungi said that it would take a full summer of labor market weakness to get the Fed to even think about a rate cut. "We're talking about a hypothetical September event here," he said.

But David Wyss, chief economist for Standard & Poor's, said part of what makes it difficult to predict when the Fed might start to cut rates is it has yet to do so under Chairman Ben Bernanke.

Wyss said in the past Fed policymakers have responded more readily to a rising unemployment rate than they have to weakness in the payroll number, even though most economists believe the Labor Department's survey of employers for the payroll figure is more accurate than the household survey used to generate the unemployment rate.

"That's the politically sensitive number," Wyss said, referring to the unemployment rate. "That also tends to be the best measure of pressure in the labor market, so it affects inflation most."

And Wyss is projecting unemployment to rise steadily throughout the year, as weakness in housing and autos starts to spread into other sectors. So he's looking for a rate cut, either late in 2007 or early 2008.

"Generally, a half-percentage point rise (in unemployment) is a trigger for a rate cut," he said. "That would mean about 4.9 percent."

He said the Fed will move to cut rates even if there is job growth in some sectors since he thinks labor market weakness is already becoming more widespread.

"Manufacturing and construction are the biggest problem but you're seeing a lot of weakness recently in retail trade, and transportation, not to mention some sub-sectors like real estate," Wyss said. "Is it going to slowdown health care? No."

John Silvia, chief economist for Wachovia, agreed that the current softness in the job market isn't enough to prompt a rate cut, given the current level of inflation. But he said that if inflation were to recede even slightly from current levels, the Fed might feel a freedom to cut rates even if the labor market doesn't get any worse.

He pointed to a measure of prices paid by consumers for goods other than food and energy, which the Fed is thought to want in a 1 to 2 percent range year over year. That rate fell to 2.1 percent in March in the latest Commerce Department report Monday, from 2.4 percent in February.

"If that thing gets down to 2 or less than 2, then the Fed can declare victory, and it opens the door for them to be easing," said Silvia.