U.S. ISM Non-Manufacturing Prices Fall Below Forecast, Highlighting Sector Divergence in Market Impact

The U.S. ISM Non-Manufacturing (Services) PMI for August 2025 painted a nuanced picture of the economy: while the headline index rose to 52.0, signaling continued expansion in the services sector, the Prices Index—a critical barometer of inflationary trends—fell to 69.2, a 0.7-point decline from July's 69.9. This modest moderation, though not a dramatic turnaround, marks the first meaningful easing in a nine-month streak of readings above 60, the threshold for sustained inflationary pressure. The data underscores a divergent market landscape, where sectors with pricing power and inelastic demand are gaining traction, while cost-sensitive industries face mounting headwinds. For investors, this divergence offers a roadmap for strategic sector rotation in a moderating inflation environment.

The Moderation in Prices: A Glimmer of Relief

The 69.2 reading for the Prices Index, though still elevated, deviates from the relentless upward trajectory seen earlier in 2025. This slight cooling suggests that businesses are beginning to absorb some of the cost shocks from tariffs and supply chain bottlenecks, or at least delay passing them on to consumers. Steve Miller, Chair of the ISM Services Business Survey Committee, noted that 12 of 18 industries explicitly cited tariffs as a factor in pricing decisions, but the pace of cost pass-through appears to have slowed. For example, a respondent in the Agriculture, Forestry, Fishing & Hunting sector highlighted the growing difficulty of absorbing tariff-related costs, yet the sector's pricing strategy has not yet fully materialized into consumer prices.

This moderation, however, is fragile. The Prices Index remains near levels last seen in late 2022, and 16 of 18 industries still reported rising costs. The Federal Reserve, which has been monitoring inflation closely, may interpret this as a sign that the worst of the price pressures are abating—but not that the threat has vanished.

Sector Divergence: Winners and Losers in a Mixed Environment

The divergent impacts of inflation are reshaping the investment landscape. Sectors with inelastic demand—such as industrials, logistics, and consumer discretionary—are benefiting from the services sector's resilience. Companies like United Parcel Service (UPS) and Delta Air Lines (DAL) are well-positioned to capitalize on e-commerce growth and business travel rebounds, even as input costs remain high. These industries can leverage their pricing power to offset margin compression, a luxury not afforded to sectors like chemicals or utilities.

Conversely, pricing-sensitive sectors such as chemicals and utilities are under pressure. The chemical industry, for instance, faces a dual challenge: rising raw material costs and weak demand from manufacturing, which has been constrained by global economic uncertainty. A recent earnings call from Dow Inc. (DOW) highlighted margin compression due to higher feedstock prices and sluggish demand for industrial chemicals. Similarly, utilities are grappling with regulatory headwinds and the inability to pass on energy cost increases to consumers in many markets.

Strategic Sector Rotation: Positioning for Fed Easing

The August data reinforces the case for a sector rotation strategy that prioritizes inflation-linked assets while hedging against potential Fed easing. Here's how investors can align their portfolios:

1. Overweight Industrials and Logistics: These sectors are poised to benefit from the services-driven economy. Companies with exposure to supply chain infrastructure, such as J.B. Hunt Transport Services (JBT) and C.H. Robinson Worldwide (CHRW), are likely to see demand gains as e-commerce and global trade normalize.
2. Underweight Chemicals and Utilities: These sectors are vulnerable to margin compression and regulatory constraints. Investors should consider reducing exposure to chemical producers and utility companies with limited pricing flexibility.
3. Defensive Hedges: While the services sector remains robust, a small allocation to defensive sectors like healthcare can provide downside protection. However, healthcare's long-term growth potential is being weighed down by rising input costs and regulatory pressures.

The Federal Reserve's next move is critical. With the Prices Index still above 60, the central bank may delay aggressive rate cuts, but the moderation in inflation could pave the way for a gradual easing cycle by year-end. Investors should prepare for a bifurcated market environment: one where sectors with pricing power outperform, and another where cost-sensitive industries struggle to adapt.

Conclusion: Navigating the New Normal

The August ISM Non-Manufacturing report is a reminder that the U.S. economy is operating in a high-inflation, low-employment environment. While the services sector remains a pillar of growth, the persistent cost pressures necessitate a strategic approach to portfolio construction. By rotating into sectors with pricing power and hedging against inflation-sensitive industries, investors can position themselves to thrive in a world where divergence is the new norm.

As the Fed contemplates its next steps, the key will be to balance the need for rate cuts with the reality of stubborn inflation. For now, the data suggests that the market is already pricing in a pivot—those who act decisively will be best positioned to capitalize on the opportunities ahead.