Cognitive Dissonance: Services Sector Edition

Call off the recession. Maybe.

A key gauge of US services sector activity defied a dour signal from an alternative survey, suggesting the biggest part of the world’s largest economy began the third quarter on solid footing.

ISM services printed 56.7 for July, well ahead of consensus and above the highest estimate from five-dozen economists. The range of (educated) guesses was 51-55.9.

The upbeat print stood in stark contrast to S&P Global’s gauge, which was revised only marginally higher from the abysmal flash reading that triggered recession alarm bells last month. The divergence between the indexes is glaring, albeit hardly unusual (figure above).

I should note that there are compositional factors that may account for some of the disparity. For years, those inclined to sensationalizing even the appearance of cognitive dissonance juxtaposed the Markit PMIs with ISM in an effort to suggest “someone has to be wrong.” I’m not sure that’s the best way to conceptualize of the juxtaposition. When you hear “someone has to be wrong,” ask yourself this: What if, instead, nobody’s right?

Activity and new orders were strong in the ISM survey — both printed near 60. The employment gauge moved back near the 50 demarcation line after slipping to 47.4 in June. Labor market mismatches continue to bedevil the services industry. The latest JOLTS figures suggested ongoing churn in leisure and hospitality, where at least 800,000 people have quit a job every month since last summer.

“Services firms raised workforce numbers further, as companies sought to fill vacancies [but] the pace of job creation was the slowest since January amid reports of struggles to find suitable candidates and, in some instances, the non-replacement of voluntary leavers in an effort to cut costs,” the color accompanying the S&P Global release said.

Notably, the prices paid gauge in the ISM report dropped to the lowest since February of 2021, consistent with the narrative that price pressures are abating (figure below).

Earlier this week, the ISM manufacturing survey for July was accompanied by the largest monthly drop in the prices gauge in a dozen years.

Anecdotes from ISM respondents were anything but ebullient. “Restaurant sales have softened,” someone in Accommodation & Food Services reported. A panelist from the construction industry said cancellation rates are up and “homebuyers can no longer afford the monthly payment.” Another respondent, from management and support services, said their industry “can feel the economy weakening.” In retail, firms are “in inventory reduction mode, attempting to match inventory levels to current lower sales trends.”

In the context of those (and other) anecdotes, you might be tempted to suggest the rosy headline ISM print belies the underlying mood as the economy softens. But much as it was possible to spin ISM manufacturing as a “Goldilocks” report, the same description was bandied about Wednesday to describe the services gauge.

Meanwhile, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, painted a picture of recession. I’m not sure there’s any way around that characterization of his remarks.

“Tightening financial conditions mean the financial services sector is leading the downturn, with a further steep rise in interest rates from the FOMC since the survey data were collected likely to intensify” the slowdown, Williamson said, adding that “higher interest rates, alongside the ongoing surge in inflation, have spilled over to the consumer sector, meaning the surge in household spending on goods and activities such as travel, tourism, hospitality and recreation seen in the spring has now moved into reverse as household spending is diverted to essentials.”

The silver lining, Williamson suggested, is that slower demand is translating into “a welcome alleviation of price pressures.”