The surprisingly sharp drop in yesterday’s release of the ISM Non-Manufacturing Index for August has unleashed new worries that the US economy is weakening as it heads into the final months of 2016. It doesn’t help that the Federal Reserve’s broadly defined Labor Market Conditions Index (LMCI) dipped back into negative territory last month. Neither of these soft numbers present a smoking gun for arguing that the US is slipping into a new recession, but the news raises more doubts about the wisdom of raising interest rates at the Fed’s monetary policy meeting that’s scheduled for Sep. 20-21.
Let’s start with the ISM data. The non-manufacturing index stumbled to 51.4, which is just above the neutral 50 mark that separates growth from contraction. Although the services sector is still expanding, the pace has suddenly turned sluggish—the weakest, in fact, in more than six years.
“When you see the ISM non-manufacturing number dropping like this, it shakes the floor on which traders are building the hopes that the Fed could increase the interest rate,” advised Naeem Aslam, chief market analyst at Think Markets UK.
The competing data from IHS Markit tells a similar story. The Markit US Services PMI dipped to a six-month low in August, with the payrolls component rising at the softest pace since Dec. 2014.
“The weak PMI readings send a downbeat note on economic growth in the third quarter,” says Chris Williamson, Markit’s chief economist. “Taken together, the manufacturing and services PMIs are pointing to an annualized GDP growth rate of a mere 1%, similar to the subdued pace signaled by the surveys throughout the year to date, suggesting that those looking for a strengthening in the rate of economic growth will be disappointed once again.”
The Atlanta Fed’s GDPNow model is currently projecting a considerably sunnier outlook for Q3—the Sep. 2 nowcast calls for a 3.5% increase in GDP for the July-through-September period (seasonally adjusted annual rate), which is sharply above Q2’s tepid 1.1% rise. But the upbeat prediction now looks like ancient history and so it’s reasonable to expect that the forecast will be trimmed when the Atlanta Fed revises the data on Friday, Sep. 9.
Meanwhile, the Fed’s multi-factor LMCI ticked back into negative territory last month. The sub-zero readings have prevailed in every month so far this year other than in July. The latest weakness isn’t particularly surprising in the wake of last week’s news that US employment growth decelerated by more than a trivial degree in August.
Note, however, that the implied recession risk probability as of August via LMCI based on probit modeling is still trivial—less than 1%. That’s in line with a broad set of indicators for modeling business cycle risk.
Avoiding an NBER-defined recession, which still looks likely at the moment, doesn’t preclude the continuation of weak growth for the US. But if the recent run of softer data offers a reason to rethink the outlook for the macro trend, there was no hint of revising upbeat expectations in speech last night by San Francisco Fed President John Williams. “The American economy is finally back in good shape and headed in the right direction,” he told the Hayek Group in Reno, Nevada.
We’re at full employment, and inflation is well within sight of and on track to reach our target. Given the progress we have made and signs of continued solid momentum in the economy, and consistent with our agreed-upon monetary policy approach, it makes sense for the Fed to gradually move interest rates toward more normal levels.
The question is whether that’s wishful thinking or just a policymaker’s happy talk that’s disconnected from the fast-moving facts on the ground? Reasonable minds can still disagree, but clarity is coming, albeit one economic report at a time.
The next installment is Thursday’s weekly update on jobless claims, which have been the poster child for optimism through this year. For what it’s worth, the crowd is expecting more of the same. Econoday.com’s consensus forecast calls for claims to hold at close to a 43-year low via a slight uptick of 1,000 to a seasonally adjusted 264,000. If this turns out to be wrong and new filings for unemployment benefits shoot higher, brace yourself for a hefty attitude adjustment.