U.S. small business sentiment rebounds in July, small businesses likely to stay optimistic

U.S. small business sentient recovered in July, settling back into the range of post-election highs. The NFIB’s small business optimism index rose in July by 1.6 points to 105.2, blowing past market expectations for a 0.1 point drop and reversing the falling trend seen at the beginning of the year. Seven of the ten index components gained ground on the month, two retrenched, and one remained the same. The report’s widely optimistic confidence was seen strongly in forward looking indicators, with expectations for economic improvement, higher sales volumes, and plans to increase employment leading the way, noted TD Economics in a research report.

Labor market indicators showed pronounced strength, as tightening conditions were seen in job openings and plans to increase employment, with both measures at their highest levels in over one decade. This has resulted in a large share of companies to increase wages recently in order to attract qualified workers, with the wage increase sub-index gaining 3 points on the month. Even if the share of companies planning to raise compensation in the next three months dropped by 2 points in July, this weakness is expected to be temporary as increasing labor market tightness should give additional support for wage rises in the future.

Companies expecting an increase in real sales rose sharply on the month, reflecting the vital role that the consumer has had in raising business confidence recently. Plans for adding inventories also rose as employers responded to the pressures of solid demand.

Even if the report released today is widely positive, the sub-index for companies with capital outlay plans in the next three to six months fell. The move erased the previous month’s gain but the index continues to be elevated, with barriers to tax reform in the White House likely still deterring some investment for some time, stated TD Economics. With continued strength in demand, there is a possibility of a recovery in this metric over the remainder of 2017.

Today’s report marks a reversing of the downward trend in sentiment that defined the beginning of the year. This is likely to due to a rebound in growth last quarter, with strength in consumer spending having shored up sentiment, and left companies less dependent on plans for tax reform to underpin growth. With this momentum in growth likely to continue in the September quarter, companies would possibly stay positive as strong demand underpins expansion.

Labor market indicators were particularly tight in the report released today, with the quality of labor cited as being the second most considerable headwind to growth for companies after taxes. Shortages of qualified workers have resulted in companies to provide more generous wages recently, with the trend auguring well for the wage and inflation outlook.

In all, the business sentiment continues to show the economy’s strengthening fundamentals, with small companies increasingly focused on actual performance instead of looking forward to tax and policy reform.

“With momentum in growth from the second quarter slated to carry over into the this quarter, small businesses are likely to remain optimistic”, added TD Economics.