US ISM services number provides further evidence of slowing activity

Today’s ISM service number from the US has provided yet more evidence that the Fed’s monetary tightening is acting as a drag on economic activity.

Following on from the poor ISM manufacturing numbers on Tuesday, today’s services figures have provided another piece of the jigsaw puzzle that is increasingly building a picture of a slowing US economy. While the ISM numbers can be noisy on a month-to-month basis, today’s numbers have continued the downwards trend that has very much been in place since the Fed began its tightening cycle. While the headline reading of 52.7 only partially reverses the unexpectedly strong June number of 53.9, the underlying direction of travel remains downwards. Despite the boost provided by last month’s reading, the index is now some 6 points below where it was in March 2022, when the Fed first started its hiking cycle. While this performance is better than that being seen in the manufacturing sector – which is lower by some 12 points – it is not unusual for monetary policy tightening to impact the goods sector before the services sector. As such, as the full impact of the Fed’s tightening starts to be felt, so the downturn in the services sector is expected to quicken.

Tellingly, perhaps, the biggest drop in the sub-indexes was in the employment component , which fell 2.4 points, a deteriorating outlook that mirrors the picture described by the manufacturing equivalent two days ago. The ISM employment indices have a poor track record in forecasting the monthly payrolls numbers, but they do provide a respectable guide to the underlying trend, and both the services and manufacturing readings are adding to the growing body of survey evidence which is pointing to a slowdown in the labour market. A more confusing picture is painted by the business activity/production sub-index, which despite falling from 59.2 to 57.1, remains at a level which suggests business is buoyant. However, this reading is at odds with real time data such as restaurant table and hotel room bookings, and is also contradicted by the fact that consumer spending has materially weakened over Q2. As such, this component appears set to weaken too going forward, and particularly from October when the planned restart of student loan repayments begins.

Combining both the services and manufacturing surveys together, the overall picture painted is one of a US economy that is slowing, but not at a break-neck speed, and suggesting that the Fed may yet achieve its objective of engineering a soft landing. But as the data increasingly points to a slowdown, so the Fed will need to begin loosening its monetary stance if this soft landing is to materialise. So far there are no signs that the FOMC is collectively willing to contemplate this, leaving open still the real possibility that monetary policy will need to be reversed sharply in 2024 if a recession is to be avoided.