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Economy in Brief

EMU Services Sector in January Slows; In Other Places, Boy Does It Ever...
by Robert Brusca  February 3, 2016

The EMU services sector turned weaker in January but stayed above 50 signaling continued, if slower, growth. The EMU-wide service sector reading was last lower in January 2015. Even so, the various averages show that the overall EMU gauge has been steady over all these horizons of three-month, six-month and 12-month at level of 54.0. The slip to 53.6 in January is a relatively sharp pullback but not severe.

Three of four of the largest EMU members showed service sector pullbacks in January. France was the exception with its services sector pulling up out of the contraction zone to edge up over 50, at 50.3. The overall euro area index fell by 0.6 points, the German index fell by one full point, Italy fell by an outsized 1.7 points, and Spain's index fell by 0.5 points.

France had fallen for two months in a row before rising in January. Spain now has fallen for two months running. And the overall EMU gauge is lower for two months running.

The EMU services gauge stands in the 70th percentile of its historic queue, implying that it has been higher 30% of the time. The German index with the highest raw reading among this group of EMU members has a 75th percentile standing. Italy, despite its lower raw score, has been higher less than 7% of the time. Spain stands in its 67th percentile. Except for Italy, this is a collection of very modest standings. The standings are at their medians when they are at their respective 50th percentiles. Standings around the 70th percentile are substantially up from their medians and should be regarded as relatively solid readings. But they are not strong readings either. The Italian case is interesting since it has a 93.8 percentile standing when its raw index is only at a reading of 53.6. Obviously, the message is that the Italian services sector does not post such high scores for services, but its relative performance is still quite good by historic standards.

The U.K., an EU member, is not in the common currency mechanism. Its services sector strengthened to 55.6 in January after falling in December. Its sequential moving averages have been without clear trend. But its three-month average advanced on its six-month average. Still, its January level is below its 12-month average. That is true also for the EMU, France, and Spain. The U.K. services metric stands only in the 52nd percentile of its historic queue of values, just a bit above its historic median. The U.K. services sector is decidedly moderate by comparison with the EMU average and the large four EMU members taken individually.

Today the National Institute of Economic and Social Research (NIESR) released an outlook for the U.K. economy that was largely unchanged with growth outlook for the year ahead held at 2.3%. The institute did push out its projection for a rate hike to the second half of the year.

In some sense, this view is consistent with the Federal Reserve's view in the U.S. which seems to see no financial sector damage from the recent stock market selloff. Today New York Fed President William Dudley suggested that he saw some tightening of credit conditions. For the moment, the Fed has left us unconvinced that its timing for a rate hike has been changed. But in truth, we cannot tell for sure from the Fed's policy statement or from recent comments by Vice Chair Stanley Fischer. The NIESR sees the U.K. rate hike at least being pushed into the future. In that, the view from the Fed and from the U.K.'s NIESR is the same: that the stock market selloff is largely a market event and will not loom large as a policy factor this year.

The day also saw a wealth to economic data and service sector reports released worldwide. These global Markit indicators seem to show relatively stronger services sectors in Europe, Japan, and India whereas they see monthly improvements in only seven of 16 service sector reporters in January. But places like Russia and Brazil have sector readings at or near their lower 10 percentile of their historic standings. China is midrange and India is firm. But the BRICS as a group are more marked by weakness. The U.S. nonmanufacturing ISM index was cut to weakest vale on this timeline (since August 2008) and now has a zero percentile standing, with its index falling by more than two points in one month. Will the Federal Reserve remain equivocal in its assessment of the U.S. economy?

Service sectors have been stable in general and have produced a buffer from what have been weak global manufacturing conditions. But this month's erratic behavior, highlighted by a sharp weakening in the U.S., shows that service sector strength is not impervious to weakness elsewhere. This tug of war remains one of the key questions in evaluating the global economy. The services sector is the jobs producing sector since manufacturing is performed with much more capital and has greater productivity. When manufacturing turns down, the knock-on effect is reduced (compared to services) because it does not hit the job market so hard. But there is a knock-on effect and that does get transmitted to services. At the moment, it is amplified by conditions in the oil market and in other extractive sector industries. These, of course, hit developing economies harder and, arguably, below the belt.

On top of that, fiscal policy globally is mostly handcuffed and monetary policy has been as stimulative as it can be most places. Central banks are all but tapped out. Central banks have tried pulling rabbits out of their hats by engaging in operations known as QE or by pushing interest rates into the negative space. These sorts of actions reek of desperation and create side effects that may actually dominate the primary impact of what the banks hope to achieve.

As a result, it is very hard to evaluate the global economy. But we can come to the simple conclusion that the Federal Reserve's take on policy is wrong. The Fed will not even establish a balance of risk statement for policy. Everyone is watching and waiting instead of doing. Since monetary policy acts with a lag whichever direction it chooses to move next in the wake of this pause, it will be behind the curve. It is not so serious being behind the curve if risks lessen since there is so much space in which central banks can act to hike rates. On the upside, bankers still have the potential for completely controlling events seamlessly. The risk of bad policy decisions still lies on the downside side (regardless of what the Fed may not say) because it is there that the flexibility to act is so limited. That is true in the U.S., the EMU, the U.K., Japan as well as in other places to a lesser extent, if conditions weaken materially (as the services sector may now be doing in the U.S.) not only do central banks and governments have less ammunition to use but they will be applying it late and tardiness is what magnifies the risk. This conclusion comes from a simple statement about how policy should be discharged called the mini-max rule. Policy should act in such a way under this rule so as to minimize the impact of the worst mistake a central bank can make should it make the wrong policy choice. Central banks are not doing this. Instead, they are doing nothing and crossing their fingers. That is not a variable in most macro-models of economic impact.

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