Business Activity in US Service Sector Expands for 3rd Straight Month

Black Friday shoppers at Abercrombie & Fitch in New York on Nov. 24, 2023. Yuki Iwamura/AFP via Getty Images

Activity in the U.S. services sector expanded for the third consecutive month in September, registering its best monthly performance in more than a year, but shrinking employment and persistent price pressures lurked in the background.

The Institute for Supply Management’s (ISM’s) Services Purchasing Managers’ Index (PMI)—a gauge of the general direction of economic trends in the services industry—rose to 54.9 in September, the highest level since February 2023.

This was up from 51.5 in August and topped the market estimate of 51.7. Anything above 50 indicates expansion.

Last month’s PMI reflected robust business activity and increased new orders. Inflationary pressures persisted in September as the consumer price index climbed to its highest since May.

But the survey’s employment index contracted for the sixth time this year.

Respondents to the ISM survey noted that companies and clients are adopting a wait-and-see approach. Many are monitoring the outcomes of the November election and observing the effects of the Federal Reserve’s interest rate cut in September.

“While the recent half-point cut is encouraging, it may take another 150 basis points to move the needle in sales,” said one individual in the construction sector.

“There is concern over the economy, and it feels like a lot of people are waiting to see which way the election goes in November before making a solid plan for 2025 and beyond,” another person in the professional, scientific, and technical services sector stated.

Overall, according to the survey results, conditions have stabilized and volatility is muted.

Confidence Dips

S&P Global released the alternative U.S. Services PMI, highlighting findings comparable to the ISM report.

Business activity slowed somewhat in September, sliding from 55.7 to 55.2. Still, it indicated solid growth in the sector as new business rose steadily.

Firms were reluctant to hire last month amid ballooning input costs and selling price inflation, fueled partly by “stubbornly elevated wage growth,” said Chris Williamson, chief business economist at S&P Market Intelligence.

“The inflation signals from the survey point to reviving price pressures, principally linked to stubbornly elevated wage growth, which could temper the Fed’s enthusiasm for further aggressive rate cutting,” Williamson stated in the report.

Companies were increasingly concerned about the outlook as business confidence declined due to uncertainty surrounding the presidential contest and growing recession risks.

“It therefore remains to be seen how the presidential election will affect growth, and the extent to which lower interest rates might help revive struggling sectors such as industrial goods and services. Clearly there are both upside and downside risks to growth,” he added.

Fed Policy

Bill Adams, chief economist at Comerica Bank, believes that the ISM survey figures could support the case for the Federal Reserve easing monetary policy at a more “gradual pace.”

Traders work on the floor at the New York Stock Exchange as Federal Reserve Chairman Jerome Powell speaks after announcing a rate increase in New York on Nov. 2, 2022. (Seth Wenig/AP Photo)my

“For the Fed, the solid economic growth and increased price pressures in the ISM survey are an argument for making further interest rate reductions more gradual than the big cut they made in September,” Adams said in an email. “The Fed will be glad to see signs that lower rates are quickly passing through to private sector activity. They are still balancing the risk of inflation rebounding against the risk that the job market’s softness deepens.”

Despite the central bank’s half-point interest rate cut at the September policy meeting, Fed Chairman Jerome Powell recently signaled that the monetary authorities would continue implementing smaller rate cuts.

“Looking forward, if the economy evolves broadly as expected, policy will move over time toward a more neutral stance. But we are not on any preset course,” Powell told a National Association for Business Economics event on Sept. 30.

Powell said his colleagues are not “in a hurry to cut rates quickly.”

The futures market anticipates a 25-basis-point reduction to the benchmark federal funds rate, lowering it to a range of 4.5 percent and 4.75 percent.

The Fed’s 50-basis-point cut might have been “another misfire,” says Nancy Tengler, the CEO and CIO at Laffer Tengler Investments.

Tengler noted that because the second-quarter real GDP growth rate was adjusted higher to 3 percent,  and inflation persists, the central bank should have been a bit more conservative.

“We believe the Fed should have taken a page out of [the Alan] Greenspan Fed that cut only twice in 1995 at 25 bps each to ensure that inflation does not pick back up as the economy chugs along,” she said in an email.

From February 1994 to February 1995, the Fed raised interest rates by 300 basis points. By July 1995, the central bank launched its easing cycle by lowering the policy rate from 6 percent to 5.25 percent in six months. The Fed cooled the economy and averted a recession.

The next two-day Fed meeting will take place Nov. 6 and 7.