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Service sector index weak, but not fatally

The August ISM index of business activity in the service sector recorded a noticeable drop that could possibly signal the onset of the double-dip recession that so many have been waiting for. But the index is still comfortably above 50, which means that the majority of service sector firms see conditions improving. It is also possible that the recent drop in the index could simply reflect the pervasive pessimism that has permeated the collective consciousness in the past few months.

In support of the view that the recent decline was more the result of psychology rather than an actual deterioration of economic conditions, I point to the action in the commodity markets, where the prices of basic industrial commodities have been rallying in recent months and are now within inches of all-time highs. I have to believe that rising commodity prices reflect a broad-based strengthening in demand worldwide, and that this in turn is supportive of an ongoing expansion in the U.S. economy. Strong commodity prices are also showing up in the prices paid component of the ISM indices (second chart above), and this effectively rules out the much-anticipated and much-dreaded deflation that has permeated the markets of late. According to the ISM surveys, fully 60% of manufacturing and service sector firms report paying higher prices. That is hardly the stuff of which deflations are made.

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