Fed Chair Janet Yellen.
Fed Chair Janet Yellen. Photo by Alex Wong--Getty Images

The Federal Reserve Just Got Another Major Reason to Raise Interest Rates

Dec 05, 2016

U.S. services sector activity hit a one-year high in November, with a surge in production boosting hiring, further evidence of strength in the economy that clears the way for the Federal Reserve to raise interest rates next week.

Monday's bullish report from the Institute for Supply Management (ISM) followed data last week showing strong job gains in November which helped drive the unemployment rate to a nine-year low of 4.6%.

"The U.S. economy looks solid heading into year-end and, backed by a tightening labor market, the Fed is set to raise rates next week," said Robert Kavcic, a senior economist at BMO Capital Markets in Toronto.

The ISM said its non-manufacturing activity index jumped 2.4 points to 57.2, the highest reading since October 2015. A reading above 50 indicates expansion in the sector, which accounts for more than two-thirds of U.S. economic activity.

Services industries reported a 4 point surge in production last month. A measure of services sector employment soared 5.1 percentage points to a 13-month high.

While industries reported a modest decline in new orders, the new orders gauge remained well above expansionary territory. A sub-index for export orders increased solidly last month.

The strong services sector sentiment was also captured in a separate survey from data firm Markit, which showed a gauge on new orders rising to its highest level since August 2015 and a measure of new business at a one-year high.

Prices for U.S. Treasuries fell on Monday, with the 30-year Treasury bond briefly falling one point on the data before reversing losses following a large block purchase of ultra bond futures. The dollar traded lower against a basket of currencies, while U.S. stocks rose.

The Fed is expected to increase borrowing costs at the Dec. 13-14 policy meeting. The U.S. central bank raised its benchmark overnight interest rate last December for the first time in nearly a decade.

The services sector survey added to last week's upbeat manufacturing survey and data on consumer spending in suggesting the economy maintained its momentum early in the fourth quarter after growing at a brisk 3.2% annualized rate in the July-September quarter.

With November's strong gains, a GDP-weighted composite of the ISM manufacturing and non-manufacturing indexes rose to 56.7, the highest reading since October 2015, from 54.5 in October.

"This level has typically been consistent with about a 3.5% annual rate in real GDP growth," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in Valhalla, New York. "Growth has been a bit weaker than suggested by the ISM data in the past year, but, even so, the data suggest good upward momentum."

The Atlanta Federal Reserve is currently forecasting gross domestic product rising at a 2.9% rate in the fourth quarter. Last month, the ISM said the majority of industries surveyed offered positive comments about business conditions and the direction of the overall economy.

Fourteen services industries reporting growth in November included retail trade, construction, finance and insurance, information, and wholesale trade. The two industries reporting contraction were real estate, rental and leasing, and public administration.

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