Service sector bouncing back
Economics in a nutshell: The services sector is bouncing back rapidly and since that is the largest part of the economy, it looks as if strong growth is just about here.
INDICATOR: Supply Managers' Non-Manufacturing Index
KEY DATA: ISM: +2.7 points; Orders: up 3.7 points: Employment: +1.6 points
IN A NUTSHELL: "The services sector is bouncing back rapidly and since that is the largest part of the economy, it looks as if strong growth is just about here."
WHAT IT MEANS: To get to rapid growth, you need just about every component of the economy hitting on all cylinders. True, you can have one or two smaller sectors soft and still get a quarter or two or robust gains. But for strong activity to be sustained, you cannot have the big dog sitting on the porch. That has been the case with the U.S. economy as minimal income gains have limited services growth. That is changing. The Institute for Supply Management's Non-Manufacturing index jumped in July, rising to the highest level since December 2005. Yes, 2005! Supporting that gain was the Markit Purchasing Managers' services sector index, which did ease a touch but was still near the record level that had been reached in June. In other words, non-manufacturing firms seem to have turned the corner. The rise in business activity was driven by surging new orders as thirteen of the sixteen industries reported gains. Exports didn't accelerate but import orders did. With factory orders up by a robust 1.1% in June, it is clear that someone is buying lots of goods and now we see services as well. The strengthening demand is translating into new hiring. Inventories are growing, but minimally and that may lead to even more activity going forward, especially since backlogs continue to expand.
MARKETS AND FED POLICY IMPLICATIONS: The economy has seemed poised to break out before and we have been disappointed so I will believe it when I see it, but the data are really pointing to strong growth. The employment report was not as great as hoped for but the data don't go in a straight line. Don't be surprised if the August gain is above consensus. But even with the less than hoped for rise in payrolls and the modest increase in the unemployment rate, the labor market situation remains positive as unemployment claims are at levels not seen in forty years. Since both manufacturing and non-manufacturing accelerating, it is likely that the labor market will tighten further. But wages will likely remain restrained as businesses still don't think they actually have to raise compensation. It may take a jump in employee turnover before the reality strikes home and we may not see that until much later this year. Regardless of the timing, it is coming and the Fed is going to have to deal with it. Chair Yellen seems to believe that she can wait until she sees the whites of wage inflation's eyes until pulling the trigger so don't expect a whole lot of talk about rate hikes for a while. But that discussion, as well as information about how and when the Fed intends to shrink its balance sheet, needs happen in the public view soon. The Fed has done great work in getting the economy to this point and now we have to know how it intends to unwind the crisis-based policy it has been operating under for the past seven years. As for the markets, who knows what investors are worried about right now? While this report should be positive, that doesn't mean the markets will look at it that way or even consider it an important aspect of today's trading.