ISM Non-Manufacturing Index Signals Slower Growth

At 53.9, the ISM non-manufacturing index remains in expansion. The details of this report suggest the service sector continues to hold up better than manufacturing, though signs of tariff-related pressure are evident. 

Resilient But Not Immune

The ISM non-manufacturing index declined 0.8 points to 53.9 in November (top chart). While the index has been in a trend decline since the start of the year, the deterioration has not been as abrupt as its manufacturing counterpart, and more notably the non-manufacturing index has remained in expansionary territory. While the service sector is not immune to traderelated uncertainty, there is still limited evidence of a more pronounced spillover of weakness from the manufacturing sector. In other words, the service sector should continue to expand.

Current conditions faltered in November. The largest retrenchment came in the business activity component, which declined 5.4 points, to 51.6, its lowest level this cycle. Perhaps the best indication that the service side of the economy is holding up, however, is the forward-looking new orders component. New orders rose 1.5 points in November, and the gap between manufacturing and non-manufacturing orders remains fairly wide at 10 points (middle chart).

Another welcome development was the 1.8-point gain in the employment component, which pushed the index up to 55.5, the highest level in five months (bottom chart). The employment component is a good indication of near-term payroll growth, with this month’s bounce suggesting our estimate for Friday’s employment report of 190,000 net new jobs remains reasonable.

The service sector as a whole remains resilient to the continued trade skirmish, but as we previously mentioned, it is not immune as some effects from trade-related uncertainty have surfaced. Several respondents highlighted cost pressure specifically linked to tariffs. The prices paid component has been inching higher in recent months and rose 1.9 points to 58.5 in November. Imports have also wobbled recently. The import index remained in contraction for the third straight month, as the 3.5-point decline in November pushed the index to 45.0, which rivals only July 2012 (44.5) for the lowest level since the start of 2009.

This report does not materially change anything for the Fed. The FOMC signaled it will be on hold for at least its meeting next Wednesday and we expect that remains the case. The Fed cited that a “material” deterioration in the outlook as a requisite for another cut, and we do not expect the recent moves in the ISM indices justify that at this point.

We expect consumer spending to slow to about a 2% annualized pace over the next few quarters. That still-solid pace of spending coupled with an expected rebound in the housing market should support the service sector. As such, we expect the service sector to continue to expand, but it will likely at a slower pace.

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