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As federal stimulus fades, private hiring falters

As the impact of government stimulus fades, job creation will have to come from growth in the private sector. The latest data on the job market weren't encouraging.

Friday's employment report underscores the critical transition now underway in the U.S. economy. As the impact of government stimulus fades, job creation will have to come from growth in the private sector.

The latest data on the job market weren't encouraging.

A wave of hiring by the government brought a surge in employment; some 431,000 jobs were added for the month. But almost all of them were temporary Census Department jobs that will last for only a few weeks or months. Private sector employers added just 41,000 net new workers to their payrolls in May. Payroll gains were revised downward for March and April by a combined 22,000.

Even forecasters who are upbeat about the economic recovery were discouraged by the numbers.

“You’ll need to see (job gains) of about 200,000 to be considered a serious advance,” said Robert Barbera, chief economist at ITG.

The large number of census jobs added in May will also weigh on employment data in the months ahead. As those short-term jobs expire, they’ll count as jobs lost in the upcoming payroll data.

After a deep contraction that sidelined more than 8 million workers, the U.S. economy posted solid gains in the second half of 2009 and the first quarter of this year. The big snap back was fueled by two powerful forces. First, after panicky businesses slashed production deeply during the recession, inventories of unsold goods all but dried up. A surge in restocking lifted production. But so far, it hasn’t been matched by a big increase in demand.

A bigger tailwind came from an historic boost from the federal government — in the form of hundreds of billions of dollars of emergency spending and tax cuts. That stimulus effect has now largely played out, which means the positive impact on the economy is now beginning to fade, which is expected to bring a slowdown later this year. Economists at Goldman Sachs figure GDP growth of three percent in the first half of the year will fall to 1.5 percent in the second half.

The expiration this month of the tax credit for first-time home buyers, for example, is expected to bring a sharp pullback in home sales this summer. The May employment data — showing a drop in construction jobs — may already reflect that housing slowdown, according the Wells Fargo chief economist John Silvia.

Government hiring is also under severe pressure as state and local government’s struggle with a sharp drop in revenues and big budget deficits. Unlike the federal government, state and local agencies can’t borrow to fund the shortfall, which bring more immediate pressure to cut spending. In May, state and local governments cut 22,000 jobs; with more budget cuts looming, those layoffs will likely continue in coming months.

Last month’s employment report — showing a gain of 218,000 private sector jobs in April — had offered hopeful signs that the job market was gaining strength even as government stimulus was winding down. But the numbers for May has cast doubt on that scenario.

“V-shaped recoveries don't have months where we create 40,000 jobs,” said Dan Greenhaus, Miller Tabak's chief economic strategist.

The weak showing for the job market in May also cast doubt on the stock market’s increasingly wobbly advance. European stock markets sold off sharply as the numbers were released, followed by slumping U.S. stock markets.

Other measures of the job market’s strength in May were also mixed. The number of job wanted ads was flat, according to a survey by the Conference Board. An employment survey by the Institute for Supply Management posted a modest gain. Payroll processor ADP reported weak private sector job gains of 55,000 net new hires. The number of people collecting unemployment benefits rose a bit, and the level of new jobless claims is running about 450,000 a week. That’s higher than during past economic recoveries .

“The two areas of potential vulnerability for the economy remain payrolls and housing — and they're both staggering a good deal,” said Art Cashin, UBS’ director of floor operations at the New York Stock Exchange. “And we keep losing close to 1 million people every two weeks. If we're not adding them back in, this is going to be a problem.”

There were some hopeful signs in the numbers. The length of the average works week ticked up a bit, as employers added hours for existing workers. That’s usually a sign of a pickup in demand which, if it continues, will lead to more hiring.

The increase was especially strong in the manufacturing sector, where the average work week increased by 0.3 hours for the month — triple the overall gain in hours worked.

“That's really important because that gives us a gauge of strength in industrial production,” said Chris Probyn, chief economist at State Street global Advisors. “And it looks to me as if the manufacturing hours puts a nice increase in industrial production in the month of May.”

Wages also inched up a bit a bit in May, which will help support consumer spending

“You can add a million jobs but if everyone gets paid 20 cents an hour it won't make a difference,” said Dan Greenhaus chief economic strategist at Miller Tabak. “You look at jobs to see what people's incomes are and their spending power.”

The overall numbers also mask big disparities in the job outlook for different sectors of the workforce.

Nearly half of those looking for work have been out of a job for more than six months. Older workers — those over 55 — are out of work longer that younger age groups. Nearly 60 percent of older workers were out of a job for six months or more compared to 44 percent of younger workers.

Low-skilled workers are faring much worse than the headline numbers suggest. The unemployment rate for those without a high school diploma rose to 15.0 percent in May; the rate for workers with a college degree fell to 4.7 percent.

“That disparity reflects the continued evolution of labor demand in America over the last twenty years,” said John Silvia, chief economist at Well Fargo.