San Francisco Frontiers - US services activity shrinks for first time since May 2020

The Institute for Supply Management's services index dipped below a key 50-percent threshold, indicating a contraction and surprising economists.

The sector accounts for two-thirds of the world's largest economy and has held up in spite of a forceful campaign by the Federal Reserve to cool demand and rein in surging inflation -- but the higher interest rates now appear to be biting.

The ISM services index "ended a 30-month period of growth, contracting for the first time since two straight months of sub-50 percent readings in April and May 2020," said ISM survey chair Anthony Nieves.

The December reading came in at 49.6 percent, with the business activity index and new orders index both plunging.

While supplier deliveries were faster in December as logistics problems eased, "employment contracted due to a combination of decreased hiring due to economic uncertainty and an inability to backfill open positions," Nieves said.

"The holiday season contributed to the continued growth in business activity, albeit at a slower rate," he added.

- 'Startling' -

"The alarming 10.8-point plunge in new orders came out of the blue," said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

According to the ISM survey, comments from respondents noted that "high interest rates for mortgages have slowed sales dramatically," while orders were softening or in some cases, being canceled.

The real estate and entertainment sectors were among industries reporting a decline in new orders last month, ISM added.

While monthly numbers may fluctuate, "the headline number is startling and a repeat performance in January should set alarm bells ringing," Shepherdson warned.

For now, "business is slower than usual," said a survey respondent in the agriculture sector.

Another respondent from the property sector added: "We are optimistic, although concerned, about continued inflation pressures... and supply chain issues that just won't go away."

"Increasing interest rates are dampening the residential housing construction market, which only adds to the concerns," the respondent said.

But Oren Klachkin of Oxford Economics said although the latest data point to weaker activity in 2023, "we are still quite a ways from a significant slowdown."

"It's important to remember that softer readings on the economy are a feature, not a bug, of the Fed's rate hiking campaign," he said.

E.Jones--SFF