Figuring Out The 'Services Economy'

Includes: RINF
by: Jeffrey Snider

The Markit Services PMI flash reading for March rebounded from the sub-50 reading in February, but only slightly. The calculation continues to suggest that the "services economy" is following the manufacturing and "goods economy" even if with some lag. The internals of the survey were not any better, with the new orders component falling to the lowest level of the relatively short series. From Markit last week:

U.S. service providers indicated a return to business activity growth during March, following a decline that was partly driven by east coast snow disruptions in February. However, the rebound in services output was only marginal, suggesting an underlying slowdown in growth momentum so far this year. At the same time, latest data indicated that new business levels expanded at the weakest pace since the survey began in October 2009.

With the ISM Non-Manufacturing version also decelerating sharply since last fall, the anecdotal suggestions appear to be continued slowing if to some as-yet unknown extent. There should be some solid data to confirm or deny the thesis, but the Commerce Dept.'s PCE data has been so volatile of late that it's reliability is in question. In some ways that isn't surprising given that far too much of what counts as "spending" on especially services is either completely made up (as in purely phantom activity) or imputed, thus interjecting even more potential bias.

The data variability also infests the national income accounts, as they have been equally subject to continuous revisions (almost always downward). The net result is the personal savings rate that when plotted with each revision looks like the branch of a tree rather than a stable data series conducive to honest analysis.

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The latest updated version shows the savings rate still higher than in 2013 and 2014 even if we hold no confidence as to its actual range. It is at least consistent with the idea that overall consumer spending is not robust or even improving, and nowhere near what would be harmonious with either the unemployment rate or the predicate potential for "overheating."

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The reason for that is, as always, the lack of income growth spread across the whole economy. Real Disposable Personal Income (DPI) per Capita has barely budged since 2012, and hasn't been much better of late. In the past year going back to February 2015, Real DPI per Capita is up just less than 2%. Since June 2012, incomes are up not quite 4% total, or about 1.1% per year compounded. That limited gain in per capita terms suggests again the participation problem further complicated by wages (for those that have been fortunate to find work, however, many new jobs might actually exist) that have yet to figure toward Yellen's economic vision.

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The latest revisions for income once more are weaker than suggested last year, as the sharper upward turn just never seems to materialize no matter how many times the Commerce Dept. suggests it. In fact, incomes were revised materially lower from estimates produced just two months ago, which would be far more consistent again with broader observations.

Weaker incomes do align with both the "manufacturing recession" and at least the increasing idea of the services slowdown and potential contraction. In nominal terms, growth in Personal Consumption Expenditures (which include both goods and services) has slowed back to levels usually reserved for recession. The problem is sorting out the effects of "inflation," which under the "rising dollar" oil crash has meant lower calculated inflation. As nominal spending decelerates, the net in "real" terms has done the opposite because of the construction of the deflator, which seems to have led to confusion about what consumer spending has been truly like over the past year or so.

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Given what we observe elsewhere, including continued weakness in incomes, it seems as if the nominal version of PCE is the most relevant. That counts not only for the potential cyclicality of both manufacturing and services lately but also in the structural view of what sure looks to be a shrunken economy or deviated potential. Nominal PCE has never fully recovered from the Great Recession; throughout the 1990s and even the middle 2000s of the housing mania, nominal spending grew consistently at around 6%-7%. Apart from a few months in later 2014, nominal spending (which again includes imputations and phantom activity) has been less than 4% since 2012.

Under the "rising dollar" of collapsing inflation, that has projected better "real" spending growth but that just isn't consistent with either a manufacturing recession or the sharp deceleration in services measured elsewhere. Not only are consumers not spending their gasoline savings, they aren't spending anywhere close to historical rates. Given the large and continuous revisions throughout all these figures, it isn't at all clear to what extent consumerism might be so blighted. At the very least, there isn't much if anything to suggest that services are the answer; instead, far more is left in the direction of the PMIs.

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