The U.S. service sector, resilient, self-sustaining and considered by many economists as largely insulated from global turmoil, slowed considerably last month, following manufacturing lower, and hinting that the New Year's economy will be no better than the stagnant old.
The Institute for Supply Management's (ISM) non-manufacturing index dropped to 53.5 in January from 55.8 the prior month. It was the sector’s weakest expansion in almost two years and its steepest four month drop since the recession. In October the index had registered 58.3, its third highest score in the six years since the financial crash. Economists had forecast a reading of 55.1. The division between expansion and contraction is 50.
The dollar fell against the euro and the yen, touching 1.1145 verusu the European currency, the lowest since October 22nd and shedding more than 2 percent against the Japanese currency, as traders bet the Federal Reserve will be unable to raise interest rates in March.
While the service index remains above the expansion level, the swift decline in the months from October, months in which the manufacturing index was in contraction, indicates that the fall in the producing industries, itself reflective of the global economic slowdown, is beginning to effect activity in the much larger service sector. Service industries comprise between 85 and 90 percent of U.S. GDP.
The ISM non-manufacturing survey which polls purchasing managers, surveils a wide array of industries including utilities, leisure, retailing, agriculture, travel, health care, and construction.
The American economy grew at a 0.7 percent annualized pace in the fourth quarter, according to the Commerce Department’s initial estimate. Growth has declined from 3.9 percent in the second quarter and 2.0 percent in the third. The Commerce Department estimates that the economy grew 2.4 percent overall in 2015 beyond the level of the prior year.
Personal consumption, which accounts for about 70 percent of GDP, moderated to a 2.2 percent pace in the fourth quarter, according to Commerce, from a 3.0 percent pace in the prior quarter. Business investment shrank at a 1.8 percent rate, the first drop since the third quarter of 2012.
The Atlanta Federal Reserves’ GDPNow model’s initial estimate for first quarter GDP was 1.2 percent issueon February 1st. The next update will be this Friday the 5th after the international trade report. The final forecast for the fourth quarter of last year was 1.0 percent, 0.3 percent above the actual number.
Traditionally the manufacturing sector and its index has been a leading indicator for the economy as a whole. Manufacturing executives, because of the longer lead time for production endeavors, must try to predict econmic activity a year or even two in advance.
Of the five instances when the manufacturing index fell below 50 for four months or more in the past 25 years three were followed by recessions, 1991, 2001, and 2007. The index fell below 50 for several months in mid-1995 and 1998 but the economy did not contract.
The ISM manufacturing index was at 48.2 in January, a slight improvement over December’s 48.0, which had been the weakest reading since June 2009, the last month of the recession. This measure had first dropped below 50 in October, the month that the non-manufacturing index began its decline.
Historically the services index maintains a positive spread over manufacturing. That difference had widened to 8.9 in October, one of the widest gaps on record. In the last 15 years only November 2000 at 9.8 saw a wider differential.
A rapid growth in the spread between the manufacturing and service indexes is a sign of stress in the economy and can be an indicator of impending recession. One grea exception to this was in 2008 when the economy deteriorated so quickly and the knowledge was so widespread that both indexes fell in tandem.
Details of the January ISM services survey were not encouraging.
Business activity slipped to 53.9 in January from 59.5, the lowest reading in over three years and the biggest one month drop since November 2008. This gauge is the counterpart of the ISM manufacturing survey’s production index which rose to 50.2 in January, its first essay above 50 since October.
New service orders fell to 56.5 in January from 58.9 prior. It was the lowest reading for pending business since September's 56.4.
Manufacturing new orders rose to 51.5 in January, their first jump above 50 since October. The share of responses in the services survey noting fewer orders jumped to a two year high of 23 percent.
The services employment index fell to 52.1 in January from 56.3 the month before, matching the level of last January and the lowest since April 2014.
The index of prices paid by business tumbled to 46.4, the first contraction in three months. Prices have been in general decline since early 2001 when the index reached 70.7 in April. A sustained drop in prices is often associated with declining consumer demand.
Despite the negative direction of both ISM surveys, the economy retains areas of strength. Housing and car sales remain strong, both benefitting from low lending rates. Job creation, as the Fed notes continuously, has seen the best two years in fifteen.
Friday’s Non-farm payroll for January, forecast to fall to 190,000 from 292,000 will go the far, at least in the minds of the markets, to indicate whether the more than six year old expansion has a bit longer to run.
Chief Market Strategist
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