The services sector grew slower than expected in September, the Institute for Supply Management said Thursday, and orders and employment also showed weakness.
The non-manufacturing index fell to 52.6 in September from 56.4 in August, its lowest read since August 2016, while orders dropped to 53.7 from 60.3 and employment declined to 50.4 from 53.1. While the numbers show expansion, they confirm the expectations of a slowdown in growth this year that had been more noticeable in the manufacturing realm.
Economists polled by IFR Markets expected a 55.0 reading.
“Manufacturing only represents around 15% of private economic output,” said Jeffrey MacDonald, head of fixed-income strategies, Fiduciary Trust Company International. “The balance is in the non-manufacturing sector so a slowdown there represents a much more meaningful impact to overall GDP growth for the U.S.”
The employment component "barely hanging on to an above-50 expansionary level at 50.4,” shows “the pace of hiring is slowing somewhat, [as] confirmed by yesterday’s ADP payroll miss at 135k vs 140k and downward revisions to previous reports. Friday’s non-farm payroll report will be watched closely to see if this slowing trend of data from the labor market will continue to be confirmed,” he said.
The “two disappointing ISM reports” helped pushed the odds of a cut at the Federal Open Market Committee’s Oct. 29-30 meeting to 90% from 45%, MacDonald said.
While these reports are “soft” data, the “hard data — actual readings of economic and employment activity — still suggest a recession is not imminent.”
The ISM non-manufacturing report’s “outlook was much gloomier than expected,” according to Dec Mullarkey a managing director at SLC Management. “The respondents are mostly concerned about trade and tariffs, which echoes the exact sentiment that’s forcing manufacturing to contract.”
The softness should “be a wake-up call to trade negotiators that the robust pulse of the U.S. economy is starting to fade under the constant threat of escalation,” he said. “The U.S. and China need to temper their standoff and show some willingness to deescalate in their upcoming meeting. The economy is at an important inflection point. As the consumer starts to worry about the ongoing tariff drag, they could quickly retrench and stall the economy.”
Unless Friday’s payrolls number is “stunning,” Mullarkey said, “this data almost assures that the Fed cuts rates later this month.”
Before the numbers were released, Federal Reserve Bank of Chicago President Charles Evans pointed to solid economic fundamentals despite softness in manufacturing. In a televised interview, he said the growth outlook is "pretty good,” though uncertainties and shocks could derail growth.
"If there is an event that shocks the world economy or the U.S. economy, these modest [rate] adjustments are not going to be nearly enough, this is very much just risk management to help make things work out better as we strive to bring in growth at about 2% over the next 18 months," Evans told a conference in Madrid, according to reports.
Tony Bedikian, head of global markets at Citizens Bank, said, “Both reports were disappointing and obviously headed in the wrong direction, but one number doesn’t make a trend so we don’t see them as causes for alarm yet.” Friday’s employment report and third-quarter corporate earnings will offer another glimpse of the economy’s strength.
Despite the weak ISM reports, “overall fundamentals, in particular consumer behavior, don’t point to a recession on the horizon as of yet,” Bedikian said. “The U.S. consumer is still quite strong.”
Another vote that the U.S. is not on the brink of recession comes from the Payden & Rygel economics team. They discount the weakness in the ISM manufacturing report because of previous “false alarms” in this cycle (in 2012 and 2015-2016) “and dozens of false alarms dating back to 1948.”
The economists note the IHS Markit manufacturing index grew to a five-month high of 51.1 in September. “The IHS Markit manufacturing metric is less volatile, takes into account a larger swath of firms, and includes smaller companies that may be less affected by global trade sentiment and headlines,” the economists say. So while they see a slowdown in manufacturing, they are not ready to call it a contraction.
The global manufacturing PMI “ticked up” for a second month, they said, with fewer countries in contraction, which they called “tentative signs of improvement.”
Separately, factory orders slipped 0.1% in August, better than the 0.3% slide expected by economists, following a 1.4% rise in July. Excluding transportation, orders were unchanged in the month after a 0.2% rise the prior month. Orders for non-defense capital goods excluding aircraft fell 0.4% in the month after a flat read in July, the Commerce Department reported. This category is viewed as a measure of expected business spending on equipment.
Initial jobless claims grew 4,000 to 219,000 in the week ended Sept. 28, while continued claims fell to 1.651 million in the week ended Sept. 21 from 1.656 million the prior week, the Labor Department reported.
