The August ISM services index rose to 55.3 from 53.9 in July but that was a touch below the forecast of 55.6. The average year to date is 56.3 and the October, pre election, print was 54.6. Thus, not much of a change since. New orders improved by 2 pts to 57.1 but still remains below the 6 month average of 58.8. Backlogs were higher by 1.5 pts to 53.5 which puts it in line with its 6 month average. Employment grew by 2.6 pts to 56.2 which is a 3 month high and above its 6 month average of 54.4 but only 11 of 18 industries saw job growth vs 14 two months ago. Only some service companies report exports and for those that do, this component rose 2 pts to 55 after falling by 2 pts in July. With inflation, prices paid did rise 2.2 pts to 57.9 and that is the highest level since January although fewer industries paid higher prices than July.
Notwithstanding the headline beat, there were still 15 of 18 industries surveyed that saw growth as seen in July. Not surprisingly agriculture, forestry, fishing and hunting saw contraction but of note was the contraction in transportation and warehousing. Any correlation to the Transportation index that is trading at the same level it did 9 months ago?
The ISM summed up the report by simply saying “The non manufacturing sector has rebounded from the prior month’s cooling off period. The majority of respondents are optimistic about business conditions going forward.”
Bottom line, I still believe the US economy is stuck in a 2% treadmill and Q2’s GDP revision to 3% did not change that as y/o/y growth was 2.2% following 2% in Q1. I get asked all the time why is the yield curve continuing to flatten and I believe it’s simply that the Federal Reserve is ramping up its tightening, however gradually, in the context of a very mediocre economy where the key interest rate group that is auto’s is now in a recession (will be helped temporarily by Houston), and the housing sector, while still pretty good, is showing signs of strain related to excessive home price gains. The 2s/10s spread is just 2 bps from matching the lowest level in nearly 10 years. Yes, inflation expectations have moderated but at 1.78% out 10 years, it is still well above its 2016 low of 1.20%. Therefore, I think a 2.07% 10 yr yield genuinely reflects concerns about the ability of the US economy to handle Fed tightening.
Speaking of tightening, the Bank of Canada surprised the market with another rate hike and now fully takes back the two emergency rate cuts after the oil collapse in 2014. Their benchmark rate is back to 1% and the Canadian $ is ripping higher to a 27 month high in response. The BoC said “Recent economic data have been stronger than expected, supporting the Bank’s view that growth in Canada is becoming more broadly based and self sustaining.” They also acknowledged the recent rise in industrial commodity prices. There was not an indication on what they will do next as they expressed some uncertainties but with some optimism.