KEY DATA: ISM (NonManufacturing): -3.9 points; Orders: -1.8 points; Employment: -6 points; Backlogs: +4.7 points/ ETI: +2.14 points
IN A NUTSHELL: “The easing of activity in the nonmanufacturing segment of the economy may be due more to labor issues than demand.”
WHAT IT MEANS: From all accounts, it looks like the summer party is on. Mobs of people are out and about and seemingly spending money like crazy. Yet the Institute for Supply Management’s NonManufacturing index fell solidly in June. Are our eyes deceiving us? Probably not. So, what is going on? Well, in today’s report, the details were mixed. On the concerning side, business activity was off sharply. There was a major rise in the share of firms reporting a decline in activity. However, on an absolute basis, the level of the overall index and business activity are both quite strong. It is just that there were record highs set during the previous three months. Another negative component was employment. But the problem here is that firms cannot find workers, not that they don’t need workers. Finally, there was a huge rise in backlogs, as supplier deliveries are continuing to slow at a rapid pace. That points to an inability to meet growing demand.
Doubts about the labor market should have been removed with the strong June employment report released last Friday. Yes, there was an aberration in the government numbers, but the private sector did add a ton of new workers. And today, the Conference Board reported that its Employment Trends Index rose solidly in June and level is back to where it was before the pandemic hit, when businesses were trying to cope with a lack of workers. As the report noted, “A tight labor market is likely to be the new normal until the next recession.”IMPLICATIONS:The severe labor shortages are almost certainly muddling the economic data.Add to that supply chain problems and it is clear that while some data look as if they are pointing to a slowdown, what may be the case is that bottlenecks are creating output issues. The problem is that when demand exceeds supply, there is a tendency for prices to rise. At least that is what economists like to claim. And in this case, we are indeed seeing that. Unfortunately, we really don’t know how long the bottlenecks will continue to constrain activity. On the microchip front, it is hoped that conditions will start easing over the second half of the year, but some sectors could see problems for another year or more, at least that is what some analysts are indicating. That is important because the lack of chips has greatly affected U.S. manufacturing, especially vehicle production. Over the past year, the prices of used vehicles have risen faster than any other component of the Consumer Price Index except energy. On the labor front, we could see an easing of the shortages when the supplemental unemployment compensation payments disappear, but it is unclear how much that will help given the need created by the reopening of the economy. The Conference Board’s comment about being in a tight labor market until the economy crashes again is likely to prove prescient. Pressure on wages and signing bonuses will not likely disappear soon and that brings up the question I always ask: If the current price and wage pressures continue for an extended period, to what extent will they become embedded in expectations? It is hard to argue that there will be no impact, but that is what the Fed seems to be counting on.Let’s hope the Fed members are correct. Otherwise, monetary policy will have to change a lot quicker than the markets currently expect. That said, we are likely at least a year away from that possibly happening.