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U.S. Non-Manufacturing Activity Softens in July

In tandem with its manufacturing counterpart, the Institute for Supply Management’s (ISM) non-manufacturing index fell by 3.4 points to 55.7 in July. The headline print was below the consensus forecast, which called for a more moderate decline to 58.6.

Despite the decline and below-consensus print, the index remains well in expansionary territory (with readings above 50 indicating expansion), consistent with economy running above potential.

The underlying details of the report were mixed, with five out of the index’s ten subcomponents declining on the month. The biggest drops were seen in business activity, which fell by a massive 7.4 points to 56.5, new orders (-6.2 to 57.0) and backlog of orders (-5.0 to 51.5). After the latest decline, all three subcomponents now sit below their 6-month averages.

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On the other hand, prices paid (+2.5 to 63.4) rose in July as price pressures continued to build, as evidenced by the rise in this sub-index in six out of seven months this year. In addition, although the employment subcomponent has been volatile this year it managed to improve in July (+2.5 to 56.1).

Trade-related subcomponents were mixed. The imports subcomponent continued to perk up (+1.0 to 52.5) after 3 monthly declines, while export orders declined by 2.5 points to 58.0.

Comments from survey respondents remained upbeat with respect to domestic demand and the overall economy, with some concerns about price pressures, labor shortages and international trade uncertainty.

Key Implications

Similar to its manufacturing counterpart, the ISM non-manufacturing index declined in July. While survey respondents remained quite optimistic about robust domestic demand, key business activity and new orders posted large declines in the month, which could be signaling that concerns about trade uncertainty are beginning to dent confidence among business owners. The impact of tariffs was also apparent as businesses reported higher prices for raw materials. Moreover, the prices paid subcomponent is up significantly relative its year-ago level.

The employment index has declined in three out of seven months this year, so it was encouraging to see it rise in July. That being said, given the near-record low unemployment level, hiring in the services sector is starting to bump up against capacity constraints. Given the scarcity of labor it is becoming increasingly hard for companies to add to their headcount, suggesting that we will likely continue to see gradual slowing in sectoral job creation in the months ahead.

All in all, while the domestic economy remains hot, coming off a strong 4.1% (annualized) expansion in the second quarter, capacity constraints, rising input prices, and trade worries are likely to weigh on activity in coming months. As a result, we expect U.S. economic growth to decelerate to around a 3% average quarterly pace through the remainder of the year.