ISM Services Report: Expansion Continues, but Inflation Pressures Persist

The latest ISM Services Index for February registered 53.5, exceeding expectations of 52.5 and improving from January’s 52.8 reading. This marks the eighth consecutive month of expansion in the services sector, with steady growth in new orders, business activity, and employment. However, the Prices Paid Index surged to 62.6, reflecting rising cost pressures that could influence Federal Reserve policy and inflation expectations.

Headline Number and Key Subcategories

The headline ISM Services number of 53.5 indicates that the sector continues to expand at a moderate pace, maintaining a 54-month trend of growth in 57 months since the post-pandemic recovery began. The increase from January’s 52.8 reading suggests that demand remains resilient, although concerns over tariffs, labor costs, and supply chain disruptions remain key themes in the report.

New Orders Index increased to 52.2, up from 51.3 in January, signaling a modest uptick in demand. Some businesses noted preemptive purchasing ahead of tariff changes, while others reported uncertainty impacting long-term orders.

Business Activity Index edged lower to 54.4 from 54.5, but still reflects steady growth. Respondents cited strong consumer spending in early February, but some noted volatile sales patterns throughout the month.

Employment Index climbed to 53.9, up from 52.3, marking the fifth consecutive month of expansion. The labor market remains tight, with several industries struggling to fill open positions and wages continuing to rise.

Supplier Deliveries Index rose to 53.4, up from 53.0, indicating slower delivery times as demand outpaces supply availability.

Inflation Pressures and Prices Paid

One of the most significant takeaways from the February report was the increase in the Prices Paid Index to 62.6, up from 60.4 in January. This is the third consecutive month above 60, signaling rising input costs across industries, particularly in labor, fuel, and raw materials.

Wage pressures remain a key concern, with labor costs cited as a primary driver of inflation.

Commodities such as aluminum, steel, and fuel saw notable price increases, while lumber showed mixed pricing trends depending on supply conditions.

Eggs, IV solutions, and transformers remained in short supply, contributing to cost volatility in sectors reliant on these materials.

The inflationary pressures captured in this report will be closely watched by the Federal Reserve, as continued price increases in the services sector could complicate the timing of potential interest rate cuts.

Tariff Impact and Supply Chain Concerns

Tariffs on imports from China, Canada, and Mexico were a common theme in respondent commentary, with businesses adjusting pricing strategies and purchasing patterns to offset potential cost increases.

Some businesses frontloaded orders to get ahead of price hikes, which artificially boosted new orders in February but could lead to a pullback in March and April.

Others reported uncertainty in long-term planning, as evolving trade policies make forecasting costs and inventory needs more difficult.

The construction industry noted that capital equipment costs are rising, as many key components are sourced from overseas.

Notable Trends Across Industries

While 14 industries reported growth, three sectors contracted in February: management of companies and support services, retail trade, and educational services. This highlights divergence in sector performance, with some areas continuing to thrive while others face headwinds.

Finance and insurance, wholesale trade, and transportation and warehousing were among the best-performing sectors, benefitting from steady consumer spending and logistics demand.

Healthcare and accommodation and food services saw continued growth, but some respondents noted that weather disruptions and illness impacted operations in February.

Retail trade reported weakness, with companies citing softening consumer demand and inventory adjustments in response to uncertain economic conditions.

One emerging trend is that government spending and regulatory policies are playing a larger role in business decision-making, with respondents noting federal funding uncertainties and new compliance costs as potential headwinds.

Market and Policy Implications

The stronger-than-expected ISM Services reading suggests that the U.S. economy remains resilient, but inflationary pressures and tariff uncertainty are creating complications for businesses.

The rise in Prices Paid could keep the Federal Reserve cautious on rate cuts, as persistent inflation in the services sector may delay any easing of monetary policy.

Bond markets and Treasury yields may react to the higher Prices Paid figure, as investors adjust expectations for future rate moves.

The U.S. dollar could see volatility, depending on how markets interpret the inflationary pressures in the report.

Overall, this ISM Services report paints a picture of steady but cautious growth, with businesses navigating rising costs, supply chain disruptions, and shifting consumer demand patterns. With tariffs and inflation continuing to play a key role, the coming months will be critical in determining whether expansion remains steady or begins to slow.