First Factories, Now Services Signal Cracks in U.S. Economy

Services Signal Cracks in the U.S. Economy
  • ‘Shockingly weak’ gauges may make Fed rate hike tougher call
  • Economists have been forecasting third-quarter GDP rebound

Some cracks could be starting to appear in the picture of an otherwise resilient U.S. economy.

An abrupt drop in the Institute for Supply Management’s services gauge on Tuesday to a six-year low is the latest in a string of unexpectedly weak data for August. Other less-than-stellar figures include an ISM factory survey showing a contraction in manufacturing; a cooling of hiring; automobile sales falling short of forecasts; and an index of consumer sentiment at a four-month low.

While there is hardly any evidence that growth is falling off a cliff, the run of disappointing figures make it tougher to argue that the underlying momentum of the world’s largest economy is holding up. It also potentially complicates the task of Federal Reserve policy makers, who are debating whether to raise interest rates as soon as this month; traders’ bets on a September move faded further after the report on service industries, which make up almost 90 percent of the economy.

“The latest set of ISM numbers is shockingly weak,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York. “It certainly gives the doves at the Fed more ammunition. It makes the Fed’s conversation at the September meeting that much more contentious.”

The ISM’s non-manufacturing index slumped to 51.4, the lowest since February 2010, from 55.5 in July, the Tempe, Arizona-based group reported. The figure was lower than the most pessimistic projection in a Bloomberg survey. The ISM measures of orders and business activity skidded by the most since 2008, when the U.S. was in a recession. Readings above 50 indicate expansion.

Stocks fell, bonds climbed and the dollar weakened against most of its major peers after the data were released.

‘Close Call’

Shapiro said while his firm’s forecast is for a rate hike at the Sept. 20-21 meeting, “it’s a very close call and almost a toss-up” at this point given the recent data.

Goldman Sachs Group Inc. economists led by Jan Hatzius, who last week said the August payrolls gain was “just enough” for a large majority of Fed officials to support a September rate increase, on Tuesday said the ISM manufacturing and services gauges “may have some bearing” on the Fed’s decision this month.

The setback to demand for services is a surprise given that households are still spending at a solid clip and home sales remain sturdy. The weakness across services and manufacturing may reflect adjustments to capital-spending plans amid declining corporate profits.

Seven of 18 industries in the ISM services survey showed a contraction in August, including retail; arts and entertainment; transportation and warehousing; and mining. That compares with three industries in the July survey.

The report “still reflects growth, just at a much slower rate,” Anthony Nieves, chairman of the ISM non-manufacturing survey, said on a conference call with reporters. Given that the July pace seemed unsustainable, there’s a need to see how the data pan out in the coming months before concluding whether the August slowdown is a trend, he added.

Possible ‘Fluke’

Some analysts were reluctant to take the reading at face value. Ian Shepherdson, chief economist at Pantheon Macroeconomics Ltd., said the report looks like a “fluke.” In a research note, he added that the slowdown services was “just as big a mystery as the drop in the manufacturing index.”

In the services report, the business activity index, which parallels the ISM’s factory production gauge, dropped to 51.8 from the prior month’s 59.3. It was the lowest level since January 2010 and the steepest slide since November 2008.

“The reported decline in business activity is certainly not a fluke, but an accurate report of what our respondents indicate are current business conditions,” Thomas Derry, chief executive officer of ISM, said in an e-mailed note. “The reading shouldn’t really come as a surprise, given weak U.S. GDP growth reported for the second quarter and Friday’s weak jobs data, among other indicators of continued -- but tepid -- economic growth in the U.S.”

Economists still project a third-quarter rebound in economic growth after an anemic first half. Nonetheless, the latest ISM report raises some concern about whether the weakness in manufacturing is spilling over into the broader services sector.

Investors may get more clues on the Fed’s direction when San Francisco Fed President John Williams speaks later Tuesday, along with other policy makers scheduled for the coming days. The government will also release figures on retail sales and inflation next week.

Such speeches and data will “take the reins in guiding near-term Fed rate hike expectations,” Brittany Baumann, macro strategist at TD Securities in New York, wrote in a note. Still, the services gauge “does little to quell concerns over a weakening in broader economic momentum.”

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