The U.S. services sector showed stronger momentum in May as firms moved to replenish stocks and place orders ahead of projected shortages and rising costs linked to geopolitical tensions. The Institute for Supply Management's monthly non-manufacturing survey, released Wednesday, reported that a key measure of activity climbed to 54.5 in May from 53.6 in April.
A reading above 50 signals expansion in the services economy, which represents more than two-thirds of total U.S. economic output. The May result also exceeded the median economist forecast of 53.8 from a Reuters poll.
Respondents to the ISM survey flagged intensifying inflation pressures and the emergence of supply constraints as central themes. Notably, the survey recorded that costs for petroleum-related products had risen, a development respondents had not reported the prior month. The ISM noted businesses cited higher prices for energy, aluminum and fertilizers as part of the fallout from what the survey described as the three-month U.S.-backed war with Iran, which it said had severely disrupted commodity supplies.
Priscilla Thiagamoorthy, a senior economist at BMO Capital Markets, summarized the picture: "The largest part of the economy remains healthy and continues to expand, even as inflation pressures are intensifying." She added that these dynamics are likely to leave Federal Reserve officials in a wait-and-see stance.
The ISM said the increase in the services PMI followed a rise in manufacturing activity reported earlier in the week by the same institute, extending a recent pattern of broadening demand across sectors.
Breadth of expansion and industry comments
Seventeen industries within the services survey reported growth in May. Those sectors included wholesale trade, construction, public administration, accommodation and food services, utilities and retail trade. The only sector to report contraction was real estate, rental and leasing.
Surveyed businesses provided detail on the mounting cost and supply pressures. Some providers of educational services reported "starting to see increased supply constraints and associated price increases, especially for construction materials and computers like laptops and tablets." Businesses in accommodation and food services said suppliers were "trying to pass price increases for fuel surcharges and increased input costs for resin-based products and the like," and expected meaningful cost increases to affect operations by late second quarter and into the third quarter.
Wholesale trade respondents noted capital expenditure energy projects were being delayed or revised due to macroeconomic conditions. They also cited rising demand for data center power generation projects as reducing available inventory in the piping market.
Orders, inventories and delivery times
The ISM's new orders index for services jumped to 57.3 in May, up from 53.5 in April, signaling stronger incoming demand. Inventories showed a sharp increase, with the survey's inventories gauge surging to 62.5 from 53.1 the previous month - the highest inventories reading since May 2010.
ISM officials noted that businesses had drawn down inventories for four consecutive quarters prior to this rebound, marking the longest such stretch since the Great Recession. Steve Miller, chair of the ISM services business survey committee, said the sharp rise in inventories was not a cause for alarm. He pointed out that the inventory sentiment index rose by only 0.1 percentage point and that this change "indicates respondent confidence that business activity will remain strong amid higher costs."
Despite the jump in inventories, growth in backlog orders slowed in May, and exports also decelerated. Supplier delivery times remained sluggish: the supplier deliveries index eased slightly to 55.2 from 56.8 in April, with a reading above 50 indicating slower deliveries. The ISM said the elevated delivery times were in part a function of strained supply chains as demand strengthened, rather than quicker logistics processes.
Among the items still reported as constrained were computers, electronic components and memory components.
Input costs and inflation signal
The survey's prices-paid measure climbed to 71.3 in May from 70.7 in April, reaching its highest level since August 2022. The increase underscores expectations that the recent oil price shock will continue to feed through into the services sector.
The broader inflation picture remains elevated: the government reported last week that inflation rose at its fastest pace in three years in April.
Financial markets were sensitive to the data. Stocks on Wall Street traded lower after recent strong gains, the dollar strengthened against a basket of currencies and U.S. Treasury yields generally moved higher.
Labor market and employment indicators
Services-sector employment remained muted in the ISM report, with companies reporting hiring freezes or decisions not to backfill vacated positions. Separately, the ADP National Employment Report, published on the same day, showed private payrolls increased by 122,000 jobs in May, following a gain of 105,000 in April. Economists had been forecasting a rise of 117,000.
The ADP report, developed with the Stanford Digital Economy Lab, has historically been a poor predictor of the Bureau of Labor Statistics' private payrolls estimate, the ISM noted. The Labor Department's JOLTS report for April showed hiring fell and layoffs declined, suggesting that the 115,000 gain in nonfarm payrolls recorded for April stemmed from fewer separations.
Looking ahead, a Reuters survey of economists predicted payrolls likely rose by 85,000 jobs in May and that the unemployment rate held steady at 4.3 percent. Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, cautioned that indicators with stronger track records for forecasting payrolls - including hiring intentions indexes of the NFIB and regional Federal Reserve surveys and the Conference Board's job availability differential - had weakened in recent months. He said, "Evidence that the labor market is regaining momentum remains unconvincing."
Policy outlook
The Federal Reserve's policy path remains an important variable for markets and business planning. According to the CME Group's FedWatch tool, the market expects the Fed to raise its benchmark overnight interest rate, currently in the 3.50 percent to 3.75 percent range, at its December meeting.
The ISM's services reading and the jump in the prices-paid gauge add to the data points policymakers will weigh as they consider the evolution of inflation and the labor market.
Bottom line
May's ISM non-manufacturing survey described a services sector that is expanding, with firms boosting orders and rebuilding inventories in response to tightening supplies and rising input costs. While the expansion was broad-based across many industries, delivery delays, elevated input prices and restrained hiring underscore uncertainties for costs and margins as the economy continues to digest commodity and energy shocks linked to geopolitical developments.