Monday, October 5, 2015

Service sector alive and well

One of the core fears that have been driving markets of late is the fear of contagion: that the collapse of oil prices would bankrupt the oil patch, and that in turn would spread to the rest of the economy; and that weakness overseas—particularly in China and in the Eurozone—would spread to the U.S economy. So far, there's very little evidence to support those fears. Today's ISM Service Sector report reaffirms the fact that the service sector—roughly 70% of the U.S. economy—is doing just fine. The Eurozone service sector is doing just fine too.

The ISM Service Sector Business Activity Index dropped last month, but remains relatively strong compared to the past two decades.

The employment subindex is very strong compare to the past two decades, suggesting that businesses in the service sector are optimistic enough about the future of their business that they are planning to ramp up the pace of hiring. The New Export Orders subindex fell to 69, but remains strong—just above its 18-yr average.

Conditions in the Eurozone service sector are not as strong as they are in the U.S., but they are as good as they have been for the past four years. The Markit PMI Service Sector Business Activity Index for China is near the low end of its three-year range, but is still still above 50, which suggests modest expansion.

It remains the case that although credit spreads are elevated, swap spreads are quite low. This suggests that market fears are not confirmed by the financial and economic fundamentals, which remain healthy. Swap spreads have typically been good leading indicators of the health of the overall economy, and they continue to suggest that conditions in the economy are more likely to improve than to worsen. Very low swap spreads are a sign of excellent liquidity conditions and a healthy financial sector. On balance, then, there is as yet no sign that weakness in the oil patch or overseas has "infected" the U.S. economy.

In response to the Fed's decision to delay liftoff, and the relatively strong service sector report, the market breathed another sigh of relief today. As fears fell, equity prices rose. We're not out of the woods yet, but we're making progress.


Benjamin Cole said...

Lately, it seems people are getting there see legs again on China. I feel bad for Europe I think they are over-regulated and taxed, and suffer to tight money from the ECB.

My guess is that the People's Bank of China is moving to stimulus. The PBOC I believe made an error in promising to peg the value of the Yan recently.

marcusbalbus said...

ss dives when buying fixed is hot, such as when the fed is lowering or lower for longer. who cares. the real data is the blow out in hy and lev loans. check your fire, check your fire.

Marc Semaan said...

Good morning Scott,
Swap spreads became misleading indicators I feel. 10Y swap spreads turned negative as of late which is unusual. If we compare 2Y swap spread to the TED spread (3m) we have a completely different picture. So bottom line, I don't think swap spreads are sending a message related to the health of the economy or financial system.

William McKibbin said...
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