Monday Update: An Unpleasant Surprise from the Service Sector

There was only one major economic report last week, but the data it presented was a very big negative surprise. The ISM Non-Manufacturing Index, which tracks the service sector, was released on Tuesday and showed a decline from 55.5 to 51.4—a six-year low and significantly worse than the expected small drop to 54.9.

This is the index’s third decline in the past four months and the biggest drop since November 2008. Three of the four components were down, including new orders, business activity, and employment, although none actually moved into contraction territory. Most other indicators also declined, with export orders moving into contraction. Although the index continues to expand overall, the poor result confirms the weakness of the previous week’s manufacturing survey. The breadth of the bad news suggests that the business slowdown extends beyond the realm of industry.

And now for the good news, such as it is: this report makes a September rate increase much less likely than had been thought.

A look at the week ahead

This week should provide some clarity on two fronts: (1) whether consumers will continue to lead economic growth, and (2) whether the manufacturing sector is as bad as the surveys suggest.

Retail sales data for August will be released on Thursday. Expectations are for a small decline in the headline number, from flat the previous month to a drop of 0.1 percent on lower auto sales. Core retail sales, which exclude autos, are expected to do better, swinging from a decline of 0.3 percent to a gain of 0.3 percent. If expectations are met, it would suggest that consumers can continue to drive growth, but there is some downside risk here.

On Friday, the University of Michigan Consumer Confidence survey is expected to tick up from 89.8 to 91, which would ratify the increase in the Conference Board number and also break a three-month streak of declines. The expected increase is based on accelerating real income growth, low gas prices, and a strong stock market, all of which typically support higher levels of confidence. If that plays out, this report would also support the ongoing role of the consumer in boosting economic growth.

On Thursday, industrial production numbers will shed some light on the poor ISM Manufacturing results from two weeks ago. Expectations are for a substantial drop in both the headline number and manufacturing. The headline number is expected to fall from a gain of 0.7 percent to a decrease of 0.2 percent, while the manufacturing figure is expected to go from a gain of 0.5 percent to a loss of 0.3 percent.

Finally, consumer price data will be released on Friday. For the headline index, expectations are for prices to rise 0.1 percent for August and 1 percent for the year, small increases from the previous month. For the core price index, which excludes energy and food, expectations are for prices to rise by 0.2 percent for August and 2.3 percent for the year, also small increases from the previous month. Lower gas prices continue to keep the headline index low, even as the more influential core index is expected to remain above the Federal Reserve’s inflation target.

Have a great week!