The Independent Market Observer

Monday Update: Service Sector Sentiment Skyrockets

Posted by Sam Millette

This entry was posted on Jul 13, 2020 12:50:31 PM

and tagged In the News

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In his Monday Update, Commonwealth’s Sam Millette highlights the service sector, inflation, industrial production, retail sales, housing, and consumers. Last week was relatively quiet on the economic update front, with only three major data releases. The highlight of the week was the ISM Nonmanufacturing index, which showed that service sector confidence rebounded by far more than expected in June. This week, we’ll get numerous important updates, with a focus on consumer inflation, industrial production, retail sales, housing, and consumer confidence.

Last week’s news

On Monday, the ISM Nonmanufacturing index for June was released. This measure of service sector confidence far surpassed economist estimates, increasing from 45.5 in May to 57.1 in June, against calls for a more modest increase to 50.2. This is a diffusion index, where values above 50 indicate expansion, so this swift rebound after confidence hit a 10-year low of 41.8 in April is very encouraging. This report marks the largest single-month increase for the index since records began in 1997, more than offsetting April’s record decline. The service sector accounts for the lion’s share of economic activity, so the rapid recovery in confidence in June is a good sign for the ongoing economic recovery and indicates that service sector confidence remains resilient. Ultimately, this report shows that the pace of economic recovery was likely faster than initially expected once reopening efforts took hold.

On Thursday, the weekly initial jobless claims report for the week ending July 4 was released. Initial unemployment claims came in below expectations, with 1.314 million initial claims filed, against forecasts for 1.375 million. This marks the 14th straight week with declining initial unemployment claims. Continuing unemployment claims also declined by more than expected, falling from 19.29 million to 18.062 million, against expectations for 18.8 million. Continuing claims are reported with a one-week lag to initial claims. The better-than-expected results for both initial and continuing claims indicate that the worst job losses of the pandemic are likely behind us. With that being said, both measures of unemployment claims are still very high on a historical basis. The stress on the job market created by the pandemic means that very real work remains to be done on the jobs front.

On Friday, the Producer Price Index for June was released. Producer prices declined by more than expected during the month, falling by 0.2 percent in June against expectations for a 0.4 percent increase. On a year-over-year basis, producer prices contracted by 0.8 percent, against an anticipated decline of 0.2 percent. Core producer prices, which strip out the impact of volatile food and energy prices, also came in below expectations, increasing by 0.1 percent against calls for a 0.4 percent rise. Inflationary pressures have largely been kept at bay over the past few months due to the massive shock to demand created by the pandemic.

What to look forward to

On Tuesday, the Consumer Price Index  for June is set to be released. Headline consumer inflation is expected to show 0.5 percent growth for the month, which would translate to year-over-year consumer inflation of 0.6 percent. Regarding headline consumer inflation, the increase is anticipated due to rising gas prices in June, which were driven up by the increased cost of oil. Core consumer prices, which strip out the impact of volatile food and energy prices, are expected to increase by a more modest 0.1 percent during the month and 1.1 percent on a year-over-year basis. As was the case with producer prices, the pandemic has served as a headwind for inflation over the past few months. Nonetheless, with consumer spending picking up notably in June, economists expect increased activity to lead to modest inflationary pressure. If the estimates hold for headline and core consumer prices in June, inflation would remain well below the Fed’s stated 2 percent target. As such, it is not expected to be a major concern for the central bank in the short term.

Wednesday will see the release of June’s industrial production report. Production is slated to increase by a strong 4.3 percent during the month, following a 1.4 percent increase in May. Manufacturing output is also expected to show healthy growth, with forecasts calling for a 5.9 percent increase in output in June. Compared to consumer data, May’s industrial production report showed a slower rebound following reopening efforts, but this can be largely attributed to a slower pace of factory openings. Given that many factories reopened in the second half of May and early part of June, the anticipated acceleration of industrial production and manufacturing output growth in June makes sense. Despite the anticipated increases for industrial production and manufacturing output, both indicators fell by double digits in April. So, even if the estimates for June prove to be accurate, this sector has a long way to go to return to pre-pandemic levels.

On Thursday, the weekly initial jobless claims report for the week ending July 11 is set to be released. Economists expect to see a further reduction in initial unemployment claims during the week, with an additional 1.25 million initial claims expected, down from just over 1.31 million the week before. If estimates prove to be accurate, this report would mark the 15th straight week of declining initial claims after a spike to an all-time high of more than 6.8 million initial claims for the week ending March 27. Continuing claims are also expected to decline from just over 18 million. Despite these anticipated declines, initial claims would still sit well above the average of roughly 220,000 weekly claims we saw in 2019. We’ll continue to monitor this weekly report until initial claim levels return closer to normal.

Thursday will also see the release of June’s retail sales report. Economists expect to see sales increase by a strong 4.5 percent during the month, following a record 17.7 percent increase in May. Core retail sales, which strip out the impact of volatile auto and gas sales, are expected to rise by 5.4 percent in June, following the 12.4 percent jump in May. May’s exceptionally strong rebound in sales was bolstered by reopening efforts across the country, which should continue to serve as a tailwind in June. High-frequency data showed a continued uptick in consumer activity early in the month; however, a slowdown in certain metrics occurred toward month-end as coronavirus case counts rose. Consumer spending accounts for roughly two-thirds of overall economic activity, so a continued rebound in sales in June would be a good sign for the ongoing economic recovery in the face of higher case counts.

The third major economic report on Thursday will be the release of the National Association of Home Builders Housing Market Index for July. This measure of home builder confidence is expected to increase from 58 in June to 60 in July. The index hit a seven-year low of 30 in April, as lockdowns forced prospective home buyers to press pause on purchases. Since this is a diffusion index, where values above 50 indicate expansion, its strong rebound since April has been very encouraging. Home builders cited significantly higher levels of prospective home buyer foot traffic in June compared with April and May as a major factor in the swift improvement in confidence. This trend is expected to continue in July due to historically low mortgage rates. Ultimately, higher levels of home builder confidence support faster new home construction, so improvements to this index would be a good sign for future home construction and the overall housing market.

Speaking of new home construction, Friday will see the release of June’s building permits and housing starts reports. These two measures of new home construction are expected to show continued recovery, with permits and starts set to rise by 6.7 percent and 20.3 percent, respectively. These measures can be very volatile from month to month, but June would mark the second straight month with increased housing starts after the index hit a five-year low in April. The record increase in home builder confidence in June is expected to serve as a tailwind for construction during the month, resulting in an anticipated increase of roughly 1.17 million annual new housing starts. If estimates hold, the pace of housing starts would reach levels last seen at the beginning of 2019. Despite this anticipated jump, however, starts would be well below January’s high-water mark of more than 1.6 million, indicating this sector is still far off recent highs.

Finally, we’ll finish the week with Friday’s release of the preliminary estimate of the University of Michigan consumer sentiment survey for July. This widely followed measure of consumer confidence is expected to increase from 78.1 in June to 80 in July. This important data release will give a first look at how consumer sentiment was affected by rising coronavirus case counts in June. The factors that have historically supported higher consumer confidence, namely low gas prices, a strong job market, and strong equity market performance, have largely shown signs of moderation over the past month, which is expected to weigh on consumer sentiment. Improving consumer confidence typically supports faster consumer spending growth, so any improvement for the index would certainly be seen as a positive development. If estimates are accurate, however, the index would still sit well below the recent high of 101 set in February. While this survey has shown a solid rebound after hitting an eight-year low of 71.8 in March, confidence is still far from pre-pandemic levels. We’ll continue to closely monitor this release as the economic recovery continues.

That’s it for this week—thanks for reading and stay safe!

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