US Service Sector Expansion Amid Rising Cost Pressures: A Mixed Picture for Investors

The US service sector showed renewed momentum in April 2025, with the ISM Non-Manufacturing PMI® climbing to 51.6%, marking its 10th consecutive month of expansion. Yet, this growth comes at a cost: price pressures surged to a 26-month high, driven by labor shortages, global supply chain bottlenecks, and trade policy uncertainties. For investors, this mixed landscape demands a nuanced approach, balancing exposure to sectors benefiting from demand recovery while hedging against inflationary risks.

The Service Sector’s Modest Growth: A Fragile Recovery?

The April PMI reading of 51.6% signals a modest acceleration from March’s 50.8%, but it remains below the 12-month average of 52.6%. While the headline number suggests resilience, underlying data reveals uneven progress. The Business Activity Index dipped to 53.7%, its lowest since January 2024, while the New Orders Index rose to 52.3%, reflecting stronger demand in industries like Accommodation & Food Services and Wholesale Trade.

However, employment remains a concern. The Employment Index rose to 49.0%—still in contraction for the second straight month—as federal budget cuts and tariff-driven cost pressures dampened hiring. This underscores a sector where businesses are expanding revenue but struggling to scale staffing, a critical constraint for sustained growth.

Price Pressures: A New Normal?

The most alarming data point is the Prices Index, which skyrocketed to 65.1% in April—its highest since January 2023. This marks the 95th consecutive month of rising prices across the service sector, with 39.6% of respondents citing higher costs for materials and services. Commodities like aluminum, beef, and labor (highlighted as a persistent cost driver) are fueling inflation, while tariffs on Chinese imports have intensified procurement challenges.

Notably, 17 of 18 service industries reported higher prices, with only Arts & Entertainment seeing a decline. Industries like Construction and Health Care & Social Assistance cited vendor price hikes, though some businesses are resisting these increases. The result? A cost squeeze that could eat into profit margins unless companies pass along higher prices to consumers—a strategy that risks stifling demand.

Sector-Specific Risks and Opportunities

The divergence between sectors is stark. Accommodation & Food Services and Wholesale Trade led growth, benefiting from post-pandemic rebound trends. Meanwhile, Public Administration and Construction lagged, hit by federal budget cuts and project delays. Investors should favor companies in resilient industries while avoiding those reliant on government funding or exposed to trade wars.

Labor-intensive sectors face a dual challenge: rising wage demands and difficulty hiring. Industries like Healthcare, which already grapple with staffing shortages, may see margins shrink further unless productivity improves.

Implications for Investors

1. Sector Rotation: Shift toward consumer discretionary sectors (e.g., travel, hospitality) that benefit from demand recovery, while avoiding sectors tied to federal spending.
2. Inflation-Proof Assets: Consider inflation-linked bonds or commodities like copper and steel, which are cited as cost drivers in the PMI report.
3. Tariff-Sensitive Plays: Avoid businesses heavily reliant on Chinese imports unless they have diversified supply chains.
4. Tech and Automation: Invest in companies offering labor-saving solutions, as businesses seek to offset rising wage costs.

Conclusion: Growth, But at a Price

The April PMI data paints a complex picture: the service sector is expanding, but at a cost. While the 51.6% PMI reading suggests the economy is still growing, the 65.1% Prices Index warns of persistent inflationary pressures. Investors must prioritize sectors with pricing power and demand resilience while preparing for potential headwinds from trade policy and labor shortages.

The key takeaway? Moderate growth is here, but it’s fragile. The service sector’s 59-month streak of expansion since 2020 is a testament to its durability, but the prolonged price increases—now in their 8th year—signal a new equilibrium where cost management is as critical as revenue growth. For now, the sector’s resilience supports a cautiously optimistic outlook—but investors must remain vigilant.

As the ISM data underscores, the US economy is still on track, but the path forward is lined with speed bumps.