Monday, December 5, 2011

Service sector report unimpressive

The November ISM service sector report was lackluster. It paints a picture of an economy that is just muddling along. There are sectors of the economy that are doing much better, however, which are not reflected in this report: mining and technology, for example. But overall the economy is growing only modestly faster than the growth of population. 

Despite lackluster growth in the service sector, and despite the economy's huge supply of unused physical and human resource capacity, more businesses report paying higher prices than report paying lower prices. This has been a persistent theme for well over a year now, and I believe it is a testament to a) the fact that monetary policy is accommodative, and b) the Phillips Curve theory of inflation is fundamentally flawed. If anything, this tells us that the risk of a monetary policy error (e.g., the Fed not having eased enough to promote a recovery) is very small at this point.

A few months ago this chart was upbeat, but now it is not. It might be reflecting the onset of a double-dip recession, but I think we would need to see meaningful deterioration in a variety of other indicators before getting worried. Consider all the positives that are still extant: weekly unemployment claims are still declining, private sector jobs are still growing, manufacturing and capital indicators are still positive, the yield curve is still steep, auto sales are strong, commodity prices are still quite elevated, industrial production is still expanding, capital spending is still strong, and corporate profits are very strong. Plus, there are increasing signs that the Eurozone is not going to give up without a fight: Italian 2-yr yields are down over 200 bps in the last 10 days, hitting 5.6% today; that's still quite elevated from an historical perspective, but it is meaningfully below the 7% level which many consider to be critical.


Bill said...

Is this a very reliable indicator of anything? It seems to zig zag all over the place and reflect current sentiment based on headlines rather than reality. I'm not sure why you think it's important at all.

seekingtraceevidence said...

ISM indicators are only useful at market bottoms. Once the economy has entered recovery/expansion they do not provide much insight. Even falling below 50, which they do often during economic expansion they fail to identify a slowing economy.
These are sentiment indicators (soft values) and often do not match economic data which are hard values but for the bottom of the recession.

Frozen in the North said...

This is bad, I count on your for positive spin to the economy. If you are going to be as gloomy as me, what's the point! Seriously, you point out a serious problem (prices) I'm not sure that it is wage driven or input cost driven.

Scott Grannis said...

Frozen: I continue to have a "positive spin" on most things, but not by design. I feel obligated to note when there are indicators that don't support my overall outlook. As for prices, they are always driven by monetary fundamentals, not by wages or input costs.

Benjamin said...

Over at Carpe Diem, Perry reports all manner of falling price indices.

With unused capacity to the moon, and falling prices, the Fed is doing a Japan.

Being accommodative is yesteryear's policy. Ii is not enough.

Times change. The Russkies are gone, and inflation is no longer the bugaboo.

The threat today is Japanitis.

The Fed must not only accommodate, but be proactive in stimulating growth. Sustained QE with the target being nominal GDP growth, as opposed to a dollar amount of purchases.

As Milton Friedman recommended for Japan.

Frozen in the North said...

Scott: I understand that you are fundamentally honest in your analysis,a nd when data doesn't support your analysis you are up front about it. Nevertheless, the data is worrying because service ISM is very important to the US economy (its such a large percentage). I'm curious about the input costs...