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  • Alex Haseldine

At Your Service

In normal cycles manufacturing leads services, and service sector activity is on average less cyclical. (Which is why we find that tracking and forecasting global industrial production is the most timely and effective way to think about global growth). In a post-COVID world, however, we would expect services to lead any recovery process. So the recent non-manufacturing PMIs were a key check-point for our thesis that the world economy is picking up speed. The good news is that China is not the only country seeing an upturn in service sector activity: new business is now picking up (strongly) from negative territory in all three major regions. The same is true for the UK, Japan and Russia (but not Brazil). Overall, however, global service sector activity is re-accelerating. That's the good news.

The less good news is that there is a slight hint of an upturn in inflation pressures as a result. The services PMI prices received index for the US ticked up from 54 to 55.4 after 10 consecutive months of declines. It won't please the Fed if that continues, but in level terms it is still pointing towards a major decline in core service sector inflation. (Figure 2).

US equity and bond markets had a tough February, as investors repriced the path of Fed policy to discount a higher peak in rates and a much slower decline thereafter. On the surface, the US Services PMI (strong hiring intentions, uptick in prices paid) added to the long list of strong data points for January published since the last FOMC meeting. And most FOMC members seem to take that strong start to the year as evidence that more rate hikes are definitely needed (for example, see the recent speech by Fed voting member Waller).

But there are a few reasons not to get too carried away with the case for still tighter monetary policy. One is that January was unseasonably warm, which means that the data almost certainly exaggerated the underlying strength of the economy (probably compounded by the impact of benchmark revisions). The second is the weekly Indeed data, which points to a steady drop in job postings across most industries and regions - figure 3. Countrywide, job postings on Indeed are now down 10% since the start of the year.

And the third is most intriguing of all: it seems that labour supply may be improving just when it is needed. Some respondents in the PMI survey mentioned that they found the availability of new workers had improved on the month which had allowed them to increase previously limited spare capacity. Likewise, a number of Q4 earnings reports highlighted an an improvement in hiring conditions for firms ranging from fast food restaurants to aerospace engineering. And the proportion of Russell 2000 earnings call that cited "labour shortages" as a major concern has steadily come down from a peak of 16.5% in Q3:2021 to just under 5% now. The labour market is still hot, but it seems that as real wages edge up again, benefits run out and COVID concerns dissipate some of the "lost" workers who left the labour force during the pandemic may be returning to work.

What may be happening is that as white collar workers return in greater numbers to the city, city service providers are also returning to work, albeit with a lag. As such, many job vacancies are finally being filled, meaning that excess demand for labour will start to trail off. If true that is seriously good news for the Fed's stated goal of getting core service sector inflation back down to more normal levels.

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