Nothing wrong with the service sector

A few days ago I argued that the market was probably overly-concerned about the prospects for U.S. growth, based on a weak ISM manufacturing report and disappointing payroll employment data for March. Today's ISM report shows that the service sector—roughly twice the size of the goods-producing sector—is doing just fine. Manufacturing was hit by temporary factors (e.g., the slowdown in West coast ports, and the rather sudden 50% decline in active oil drilling rigs in the past four months), but there is little reason to expect a significant spillover to the service sector. Money freed up by lower oil prices and economic activity made more profitable as a result of cheaper energy is likely show up as a positive for the economy in ways we have yet to see. Until we find out who the beneficiaries are, it's comforting to know that swap and credit spreads do not show any signs of meaningful deterioration in the economy's fundamentals.

As the first chart above shows, March readings of the health of the service sector in both the U.S. and Eurozone were relatively healthy, in contrast to the weaker readings for manufacturing, shown in the second chart. I'm actually quite encouraged by the improvement we've seen in the Eurozone in recent months; Eurozone equities are up 17% since the end of last year, and have outperformed their U.S. counterparts by almost 15%.

As the chart above shows, 2-yr swap spreads in both the U.S. and the Eurozone remain firmly in "normal" territory (i.e., 15-30 bps). According to this highly liquid, market-based indictor, there is to date no indication of any meaningful deterioration in the economic or financial market fundamentals.