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  • KPB & Co Research

Recent actions by the US federal reserves underscore the challenges of the new macroeconomic environment, nevertheless service oriented businesses appear to be bucking the trend. The IHS Markit US Services PMI indicated that the index tracking the services sector expanded to 53.0 in July 2019 coming from 51.5 in June of the same year, registering the fast pace of growth seen in four months. The rise in the index came on the heels of faster growth in new business signings and expanding client demand from local and international customers.

In spite of the solid rise in business activity, participants in the service sector appear to be exercising a high degree of caution, perhaps due to the constant influx of negative news about future economic prospects. Business optimism in the service sector registered back-to-back declines for sixth months in a row, going into un-travelled territory. The lack of confidence in the persistence of better economic fortunes has led many services companies to hold back on hiring, even as demand from local and external clients improve. As a consequence, capacity constraints have risen sharply. According the IHS Markit report:

the level of outstanding business increased for the seventh successive month and at a stronger pace in July. The accumulation of backlogs was solid overall and the sharpest for four months.

According to the report, average price levels for services remained subdued as businesses implemented promotional discounting to entice consumers to spend. At the same time, there were moderate increases in input costs owing to seasonal shortages and unfavourable weather conditions. The report did mention that input cost inflation was at the slowest level seen in 2 years.

IHS Markit Services Business Activity Index
IHS Markit

In our view, businesses in the service sector have valid reasons to remain cautious as there are a number of risks coming to the fore of late. At the time they were responding to survey questions, trade negotiations with China was in a state of limbo but there were no fresh negative news. Since then, President Trump proposed another round tariffs on Chinese goods, set to take effect on September 1, that will see a 10% levy on US$300Bn of Chinese imports, covering mostly clothes, toys, footwear and some electronic devices. Following the announcement of the tariffs, the Chinese Yuan devalued to the lowest level seen since 2008. According to the International Monetary Fund the renminbi is a de jure floating currency - which is a highly managed floating regime. In this context, the China could be looking to maintain competitiveness by making its currency cheaper, possibly indicating their willingness to engage in a long battle. China have also ceased all imports of US agricultural goods in a bid to get at Trump's support base.

The federal reserves have also slashed rates, and hastily ended the run-off of the bond buying program. In some respects this positive news in the sense that it shows that the Fed is has made the monetary environment more supportive of growth. On the other hand, given that market participants are expecting further rate cuts this year, the Fed's action could be indicative of more difficult economic challenges to come.

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