A sharp fall in the global manufacturing PMI new orders index in July confirms renewed industrial weakness. The companion services survey, however, reported an uptick in the new business component, which is close to its post-GFC average. Will services resilience sustain respectable overall growth?

The understanding here is that economic fluctuations originate in the goods sector, reflecting cycles in three components of investment – stockbuilding, business fixed capex and housing. Multiplier effects transmit these fluctuations to the services sector – there is no independent services cycle.

The manufacturing new orders and services new business indices have been strongly correlated historically, with Granger-causality tests indicating that the former leads the latter but not vice versa*.

Several considerations suggest that the recent divergence will be resolved by the services new business index moving lower:

1. The services future output index correlates with new business and fell to an eight-month low in July – see chart 1.

Chart 1

2. Recent new business readings have been inflated by strength in financial services – chart 2. Financial services new business correlates with stock market movements, suggesting weakness ahead.

Chart 2

3. Consumer services new business correlates with the manufacturing consumer goods new orders index, which fell below 50 in July – chart 3.

Chart 3

Output price indices for consumer goods and services support the optimism here about inflation prospects through mid-2025. A weighted average has fallen back to its October 2009-December 2019 average, a period in which G7 annual CPI inflation excluding food / energy averaged 1.5% – chart 4.

Chart 4

*Contemporaneous correlation coefficient since 1998 = +0.84. Granger-causality tests included six lags. Manufacturing terms were significant in the services equation but not vice versa.

A post in June suggested that a recovery in the OECD’s US composite leading indicator was ending. A calculation based on the latest input data confirms a reversal lower.

The historical performance of the OECD indicator compares favourably with the Conference Board leading index. The OECD indicator recovered from early 2023, signalling that recession risk was (temporarily?) receding, while the Conference Board measure continued to weaken.

The latest published data point, for June, was released in early July. The next update is due on 5 September and will provide July / August numbers.

Chart 1 shows the published series (black), a replica series calculated here based on data available in early July (blue) and an updated replica incorporating an additional month of input data (gold). The updated series has fallen sharply from an April peak.

Chart 1

The decline reflects weakness in four components: consumer sentiment, durable goods orders, the manufacturing PMI and housing starts. The two financial components – stock prices and the 10-year Treasury yield / fed funds rate spread – were still marginally positive in July but levels so far in August imply a turn lower.

The price relative of MSCI World cyclical sectors, excluding tech, versus defensive sectors has mirrored movements in the OECD US leading indicator historically – chart 2. Relative valuation is high versus history and has diverged from a weakening global manufacturing PMI – chart 3.

Chart 2

Chart 3