ISM Services PMI: A Closer Look at the Numbers

The Institute for Supply Management (ISM) Services Purchasing Managers' Index (PMI) for May came in this morning at 50.3%, a figure that was lower than the expected 52.4% forecast, signaling a slowdown in the growth of the US services sector.

Despite this, new orders have shown a promising increase, up to 52.9%. However, employment has taken a hit, dropping to 49.2%, indicating a mild contraction in the services sector workforce. Prices paid continued to rise, albeit at a slower pace, demonstrating that the potential for cost push inflation remains a problem area.

Prices Paid and Inflation

One of the key takeaways from the report is the prices figure, which came in at 56.2%. The good news is that this was a lower reading than April’s data which showed 59.6%.

Nevertheless, the data indicates that potential for cost-push inflation is still relatively prevalent in the services sector. Cost-push inflation occurs when increased production costs lead to increased prices for consumers, and rising wages are continuing to drive those increased production costs.

The industries which saw increasing price pressure were Public Administration; Information; Health Care & Social Assistance; Other Services; Educational Services; Arts, Entertainment & Recreation; Finance & Insurance; Wholesale Trade; Retail Trade; Construction; Utilities; and Professional, Scientific & Technical Services.

Thankfully wages are rising at slower rates, which may help to explain the slowing increase in ISM Services PMI prices.

Inventories and Commodities

Inventories have been building, with the index rising to 58.3%. This could indicate that businesses are replenishing inventories after finally drawing some of them down from Q4 2022’s large build. There were also some key items in short supply, that may have caused businesses to over-order, such as appliances, construction materials, electrical components, transformers, and vehicles.

The report also provides insights into the movement of commodity prices. We saw the following commodities increase in price: automobiles, beef, construction contractors, construction materials, electrical components, labor, transformers, and wood pallets.

We also saw some commodities decrease in price: bacon, international freight, and steel products.

Key Indices

Business Activity

Business activity, a measure of production output, has shown a decline, aligning with the overall PMI figure. This suggests a slowdown in the services sector's output.

New Orders

New orders, on the other hand, have shown an increase, suggesting that demand for services is still robust. This could potentially lead to future growth if businesses can meet this demand. The industries experiencing growth in new orders during May were travel and leisure, professional services, educational services, retail, utilities, construction, transportation and warehousing.

Employment

The employment index has shown a contraction, indicating that businesses in the services sector are reducing their workforce. This could be due to a variety of factors, including cost-cutting measures or a response to reduced business activity. We saw decreases in employment from agriculture, forestry, fishing and hunting, educational services, real estate, leasing, technology, finance & insurance, health care & social assistance, and wholesale trade.

Supplier Deliveries

We saw a 47.7% reading, down 0.9 from the 48.6% reading in April, showing that supplier deliveries are becoming faster.

Backlog of Orders

Backlogs fell to 40.9%, down 8.8 from the 49.7% reading in April, showing that the backlog of orders is significantly lower than what we saw just a month ago.

Conclusion

The May ISM Services PMI report shows a picture of slowing growth in US services businesses and related employment. However, price pressure remains elevated, indicating ongoing potential cost push inflationary pressures.

Inventories rising appreciably as new orders decelerate and backlogs fall significantly will be a situation worth monitoring. If we see further deceleration of new orders into negative territory and backlogs continue to fall, it is likely that overall business activity also falls and we see a negative reading on the Services PMI index.

We believe that the Services PMI falling into a sequential multi-month contraction would precede a more meaningful slowing in the labor market and economy as services are about 77.6% of the economic contribution to GDP. That’s why watching the data is important, as it can help us to model the probabilities of further economic and earnings impacts.