Disconnect between ISM services and jobless claims, nonfarm payrolls

Yesterday’s report that the ISM Non-Manufacturing Index – a measure of the broad-service sector – fell back to a level that suggested the sector was contracting again, seemingly at odds with the continued drop in jobless claims and today’s much better-than-expected nonfarm payroll numbers (see charts below).

Additionally, the sharp upward revision to October and November nonfarm payrolls suggests the economic recovery may not be as fragile as originally envisioned by many analysts – including myself, though I have been arguing against a double-dip recession.

So what gives?  A key measure of services has declined over the past two months and the employment subcomponent barely moved, rising from 41.1 to 41.6 (50 is the level at which jobs are neither being created nor destroyed). Yet, the government reported 58,000 new jobs among service industries.

The ISM’s new order subcomponent did remain firm in November, but other than that, it simply appears that the highly regarded survey, at worst, is not capturing the nascent optimism among some businesses.  At  best, it is highlighting how weak the recovery may be.  I tend to lean to the former.

Jobless claims, in my view, are an excellent barometer of economic health because falling claims indicate the economic activity is improving as companies become  more reluctant to release workers.

November’s 11,000 drop in nonfarm payrolls is the best reading in two years. 

But nonfarm payrolls are a lagging indicator in economic recoveries because businesses do not want to quickly rehire workers and be forced to lay them off if improving economic condition are temporary. 

Furthermore, firms continue to keep a sharp eye on expenses, and hiring budgets remain under the microscope.

Yes, we have a long way to go before the economy is consistently producing the level of employment needed to take a large bite out of the unemployment rate.  And the risk of a jobless recovery over the next year remains large, especially if economic gains remain modest.

But the nearly unchanged level of employment last month and the favorable trend over much of the year are a clear reflection of falling jobless claims and a signal that further gains in the economy are probably forthcoming.