Despite the Recession-Emergency-Rate-Cut Buffoonery, the Services Sector Expands Strongly on Growth in New Orders & Employment. Inflation Pressures Still On

Yves here. Given that it was Japanese officials reacting perhaps ineptly to the prospect of a Fed rate cut in September that kicked off the short-lived market swoon, it’s not clear that Fed easing will deliver the happy outcomes that US investors are lobbying for. And as some numbers crunchers have argued, the economy does not look to have weakened enough for the central bank to conclude (using that consideration alone) that lower interest rates are clearly warranted. The Fed may decide that based on more data, but it looks as if the Fed could go either way.

There is the further issue that the Democrats are pushing particularly have for loosening, arguing that the failure to do so is tantamount to favoring Trump. I’m not so sure that argument has all that much sway at the Board of Governors if there is not more evidence either of economic weakening or of inflation slackening.

By Wolf Richter, editor at Wolf Street. Originally published at Wolf Street

US service sector activity, driven by new orders and rising employment, expanded strongly in July, according to two measures of the service sector released today: The ISM Services PMI and S&P’s US Services PMI (formerly the Markit Services PMI).

The way these Purchasing Manager Indexes (PMIs) are structured, a value of 50 means no change, a value higher than 50 means growth, and a value below 50 means decline. The higher the value above 50, the faster the growth. The measurement is month-to-month.

S&P’s services PMI for July came in a 55.0, meaning strong growth, and roughly the same pace of growth as in June (55.3), the “best growth spell” in two years, driven by “solid new order growth,” which “encouraged companies to take on additional staff,” with employment at these companies increasing for the second month in a row, the report said.

The increase in employment was not enough “to fully keep up with new order growth in July, resulting in a second consecutive monthly rise in backlogs of work,” the report said.

“The reading signaled a marked monthly expansion in services activity, extending the current sequence of growth to 18 months,” the report said.

Services providers continued to benefit from consumers switching spending from manufactured goods to services, “such as travel and recreation.” Healthcare and financial services also reported “buoyant growth.” The report pointed at the “wide divergence between the manufacturing and service economies.” This process of consumers shifting their spending back to services, from goods, has been going on for two years.

Input cost inflation “experienced a further sharp rise, with the rate of inflation quickening to a four-month high,” the report said.  “Respondents indicated that higher wage and transportation costs had been the main factors pushing up input prices.”

Output inflation decelerated. “While a number of companies responded to higher input costs by increasing their selling prices accordingly, there were other reports that competitive pressures led some firms to lower their charges. The rate of output price inflation was solid, but eased for the second month running to the slowest since January,” the report said.

“Thanks to the relatively larger size of the service sector, the July PMI surveys are indicative of the economy continuing to grow at the start of the third quarter at a rate comparable to GDP rising at a solid annualized 2.2% pace,” the report said.

“The surveys saw some upward pressures on costs, especially in the service sector, which policymakers [the Fed] will likely be eager to see soften before being confident of inflation falling sustainably to target,” the report said.

The ISM Services PMI jumped to 51.4% in July. Business activity and new orders increased strongly, employment increased, and prices jumped. Backlog increased slightly. Export orders jumped – a factor also mentioned in the S&P Services PMI above. And imports also rose.

This July reading (51.4%) was a bounce from the reading of 48.8% in June, the lowest reading in four years that had contradicted by a lot, and unusually, the S&P Global reading for June of 55.3. But the weak (freak?) June was, as we now know, sandwiched between the good July (51.4) and the strong May (53.8%), the best growth in the services sector since August 2023.

Manufacturing growth has been in the doldrums after the huge surge during the pandemic, as we have pointed out here for about a year and a half. This includes manufacturing employment, which has roughly plateaued at high levelsafter the huge pandemic surge. And prices of manufactured goods have been falling since mid-2022, now at the fastest rate in two decades, coming off their spike during the era of the shortages.

But services are about two-thirds of the economy, services are also where about two-thirds of consumer spending goes, and businesses spend a lot on services too, and services are now driving the economy after the collapse during the pandemic. And as long as growth in services is firm, the economy will be plugging along just fine, even as manufacturing growth stalled.