ISM Non-Manufacturing Index Signals Improving Sentiment

The ISM non-manufacturing index climbed 3.8 points to 56.8, the strongest reading for service sector sentiment in almost a year and firmly in line with a view towards economic expansion.

More Good News for Jobs

On the heels of a better-than-expected print for nonfarm payrolls, today's ISM non-manufacturing survey lifts expectations for further job gains in the coming months. Indeed, the employment component soared to 57.4 - the highest level in almost six years. In a typical month, the ISM non-manufacturing index comes out just prior to the nonfarm payrolls number. Economists all over the country are no doubt wishing they had this input for their model before today's jobs number hit the wire.

Growth was not limited to employment. Eight of 10 sectors were in expansion territory. The next largest gains (after employment) were in new export orders, which jumped 5.5 points to 56.5, and in overall new orders, up 4.8 points to 59.4. After troubling signs of slowing orders late last year, the gains here point to continued expansion for the service sector.

Look Out for Stockpiling

While the key take-away from this report is the better-than-expected gains in employment and orders sentiment, there is also evidence of an inventory bulge. Many respondents reported that inventories were too high. That said, it appears as though businesses are taking measures to right-size their stockpiles. The inventories component slid 1.5 points further into contraction and now stands at 47.0. The manufacturing ISM, released earlier this week, also showed contraction in inventories. These sentiment measures reinforce our thinking that an inventory drawdown will be a drag on GDP growth in the first quarter. The upshot of this is that by taking measures to address inventories now while orders remain healthy, businesses will be able to maintain production levels without having to scale back in terms of output or employment.

Prices Showing Up Again

Just as with the manufacturing ISM earlier this week, today's ISM non-manufacturing report also showed an increase in the prices measure. For the past two years, producer prices have been increasing at roughly twice the rate of consumer prices, pressuring corporate profits. But, we have seen input price increases coming down on trend in the second half of last year. We will keep an eye on the prices paid component in future months, but in the absence of a major, broad run-up in commodity prices, we suspect this jump will prove to be temporary-perhaps reflecting attempts by suppliers to raise prices for the new year. In the meantime, for decision makers in the private and public sectors, the pace of inflation and modest overall economic gains will remain a challenge to profit margins.

Bottom line: Today's ISM non-manufacturing report underscores the labor market strength we saw in the payrolls report earlier this morning and suggests continued expansion in the service sector.