UNEDITED

The Federal Reserve surprised investors by dropping the phrase "considerable period" in the statement announcing its decision on interest rates. Instead of saying that "policy accommodation can be maintained for a considerable period" the Fed stated that "it can be patient in removing its policy accommodation." Fed watchers were quick to try and decipher what signal this was to the market. The prevailing thought immediately after the announcement was that the Fed was preparing the market for a rate increase sooner rather than later. While that can certainly be the case, economic developments will play a more important role that strictly time.

In September, the Fed shifted its focus to the labor markets from lackluster economic growth as the primary reason to keep its accommodative policy. At that time it described the labor markets as "weakening." By October, employment conditions were "stabilizing" and "improving modestly" in December. Today we are told that "new hiring is subdued", but "other indicators suggest an improvement in the labor market." Considering this is the main factor in the Fed's reasoning on when to finally increase interest rates, this should be the central focus for those that parse Fedspeak. The latest comments regarding the labor market were clearly a downgrade from December's "improving modestly." Therefore, replacing "considerable period" with being "patient" is not a convincing enough signal that the Fed is getting the market ready for an imminent rate hike. It will likely depend on the level of job creation.

Furthermore, analyzing the amount of discussion given to the labor market might prove worthwhile. The status of the labor market was first included in the Federal Reserve's statement in June 2003. At that time, it shared an eight word dependent clause with "product markets." In August, it received its own dependent clause that totaled six words. By October, the discussion of labor markets was upgraded to an independent clause consisting of eight words. It maintained an independent clause status December and added one word for a total of nine. This latest release contained a full sentence devoted to the labor markets for a total of 14 words. I think it is clear that the labor markets have grown in importance since last June. Unfortunately, the discussion over the parsing of the Federal Reserve's statement has almost gotten this ridiculous. Now, I have no idea if this really means anything, but as much as the Federal Reserve's statements gets analyzed, I'm almost surprised that someone has not gone down this path.

Back on a more serious note, investors are keenly focused on developments in the labor market. The discrepancy between the two surveys from the Department of Labor only compounds the issue. The household survey has shown better job creation than the establishment survey. One reason typically given is that the household survey picks up people that start their own business and gain employment without being hired as an employee. Something that leads some credence to this is the recent announcement from the Small Business Administration that it has experienced strong demand for loans.

Many of the staffing service companies discussed what trends they were seeing. Robert Half, one of the largest providers of staffing services, reported fourth quarter results this week. During its conference call the company reported several items that point to a stronger labor market:

• On a same day sequential basis, temporary consulting revenues were up in October, November, and December.
• Permanent placement revenues were up in October, and down slightly in November and December.
• During the first two-and-a-half weeks of 2004, revenues from the company's temporary consulting businesses were up 5% vs. the same period last year.
• For the first three-and-a-half weeks of January, revenues from permanent placement were up 11% year-over-year.
• The fourth quarter was the third straight quarter of sequential revenue growth in its professional staffing divisions.
• The fourth quarter was the first quarter of year-over-year growth in 11 quarters for its staffing operations.

Kelly Services reported that growth picked up in the fourth quarter as well. On its conference call it mentioned, "Year-over-year sales in this segment [US Commercial] rebounded from being down almost 3 percent in the third-quarter to plus 4 percent by the fourth. We are clearly seeing encouraging signs of improving job markets and a healthier economy." The company said that light industrial was strongest segment, while office clerical has lagged, but has started to "see encouraging sequential improvement towards the end of the third-quarter. This growth strengthened throughout the fourth."

There is evidence that the labor market is getting better. Knowing when it will show up in the government payrolls data is the big question. The rest of the economy has continued to expand. Companies are reporting strong fourth quarter sales growth and have very favorable views for 2004.

Burlington Northern, the second-largest U.S. railroad, reported fourth-quarter profit increased 12% on an 8% increase in revenue. Strength was led by a 17% increase in consumer goods. Burlington Northern expects its rail revenue to grow 7% in the current quarter, led by consumer goods. Matthew Rose, chairman and CEO, commented that it saw "incredibly strong housing starts in the fourth quarter. Our steel business and paper business have rebounded.' Shipments of agriculture products were also strong as revenues from grain shipments increased 6.6%. The company attributed the strong performance to corn shipments to China.

Caterpillar reported fourth quarter sales grew 20%. Strength was wide-spread as machinery sales increased 21% and engines sales rose 19% with volume growth being the primary driver for both categories. Europe was the weakest geographic area while Latin America and Asia were the strongest. Caterpillar's outlook is right out of the Federal Reserve's playbook. Here is the company's outlook from its earnings press release:

A worldwide economic recovery is now underway and we expect further strengthening in 2004. Global economic growth should exceed 3.5 percent in 2004, or about 1 percentage point higher than in 2003.

Record, or near-record, low interest rates initiated economic recoveries in 2003, and we expect interest rates will remain low throughout 2004. Most economies have considerable excess capacity, and inflation is generally within central bank targets. We expect that central bankers will be cautious about taking any actions that could jeopardize recoveries.

This environment should further benefit our businesses. Low interest rates and rising profits are expected to continue to encourage users to replace existing equipment. Low interest rates should also allow another strong year for housing construction. Nonresidential construction, which tends to parallel overall economic growth, should continue to improve.

Clearly that is the game plan. Wednesday, might have given a glimpse of what will happen if investors lose faith that the economy can continue to expand without causing inflationary fears. Bonds declined immediately after the Fed's statement pushing interest rates up. Equity investors sold stocks pushing the S&P 500 down over 1% for the second day in a row. This was the first time in just over a year that the S&P 500 declined 1% or more in two consecutive days. In fact, since the rally started last March, there have been only 22 days when the S&P 500 fell by 1% or more. On only 2 of those occasions was the S&P 500 down the following day. On four occasions the following day reversed enough to eclipse the prior day's loss. But, this is more of a testament to the strength of the 10-month rally than the last two days trading.