US ISM non-manufacturing index increases, but details remain constructive

The slight gain in the US June headline reading was disappointing, offsetting only a fraction of the 2.1 point decline in the index during May. Even more disheartening is the fact that much of the weakness was a result of a relatively sharp pullback in the employment subcomponent, which fell to a four month low.

However, the report also had a fair bit of upside, with leading indicators, such as business activity and  new-orders, both notching decent gains in June. At the same time, the increase in the level of inventories is encouraging, suggesting that previous headwinds from port disruptions, which were still causing problems for businesses in the wholesale trade industry in May, are finally abating.

With the ISM non-manufacturing index not far from its cyclical high reached back in November and manufacturing activity having also notched sizeable gains in each of the past two months, it would appear that underlying economic momentum is strengthening. 

"This fits with the narrative of stronger growth over the second half of the year, which might average in around 3.4% (annualized) - far better than the expected 1.2% averaged over the first half of 2015", says TD economics.
 From the Federal Reserve's perspective, continued improvements in the labor market and at least some signs that inflation is starting to move back towards target will be required before the Fed begins raising rates. To this end, last week's employment report did little to bring forward rate hike expectations as disappointment was found on many fronts within the report. 

While the decline in this morning's employment subcomponent suggests some downside risk for July employment numbers, other subcomponents paint a brighter picture of underlying economic activity in the sector. On the whole, the incoming data will be increasingly constructive, and will provide Fed members with enough confidence to begin raising rates as early as September, added TD economics.