The US services sector, which accounts for more than two-thirds of economic activity, grew at a slightly slower pace in June, according to data released Wednesday by the Institute for Supply Management (ISM). However, a closely watched employment subindex rebounded into expansion territory after three months of contraction, adding a twist to the narrative of a cooling economy.
Services PMI Dips, But Remains in Expansion
ISM's services purchasing managers' index (PMI) edged down to 54.0 in June from 54.5 in May. Any reading above 50 signals expansion, so the sector is still growing, just at a more moderate pace. The headline number was slightly below economists' expectations, but the details within the report painted a more nuanced picture.
The new orders index, a forward-looking gauge of demand, eased to 55.1 from 57.3, suggesting that business activity is softening. At the same time, the prices-paid index, which measures whether companies are paying more for inputs, fell to 67.7 from 70.1 in May. That decline offers some hope that inflationary pressures in the services sector are beginning to ease, though the level remains elevated compared to pre-pandemic norms.
Employment Bounces Back After Three Months of Contraction
The most striking figure in the report was the employment index, which jumped to 51.2 in June from 49.2 in May. This marks the first expansion in the services employment gauge since February, after three consecutive months of contraction (readings below 50). The turnaround suggests that services firms are once again adding workers, even as overall activity growth slows.
This employment rebound complicates the broader economic picture. On one hand, a resilient labor market supports consumer spending and economic growth. On the other, it could give the Federal Reserve reason to keep interest rates higher for longer, as the central bank continues its fight against inflation. The Fed has been closely watching labor market data for signs of cooling that would allow it to ease monetary policy.
What It Means for Investors
For everyday investors, the mixed signals from the ISM services report highlight the uncertainty facing markets. A slowing but still-expanding services sector, combined with a rebounding employment gauge and easing price pressures, does not point to a clear direction for stocks or bonds.
Historically, when the services PMI is above 50 but trending lower, it can signal that the economy is in a 'soft landing' scenario—slowing enough to curb inflation but not so much that it tips into recession. That scenario has generally been positive for equities, as it reduces the risk of aggressive rate hikes. However, the employment rebound could keep the Fed cautious, potentially delaying any rate cuts that investors have been hoping for.
Bond markets may react to the inflation data within the report. The decline in the prices-paid index suggests that input cost pressures are easing, which could be supportive for bond prices if it signals lower future inflation. However, the employment strength might push yields higher in the near term, as traders price in a more hawkish Fed.
Investors should also consider the broader context. The services sector has been a key driver of economic growth this year, and any sustained slowdown could weigh on corporate earnings. Companies in sectors like hospitality, travel, and business services are particularly sensitive to changes in services demand. Meanwhile, the employment rebound is a positive sign for consumer spending, which could benefit retail and consumer discretionary stocks.
Looking Ahead
The ISM services report is just one piece of the puzzle. Investors will be watching upcoming data releases, including the monthly jobs report and consumer price index, for further clues on the economy's trajectory. The Fed's next policy meeting is also on the horizon, and any shifts in the labor market or inflation will influence its decision on interest rates.
For now, the message from the services sector is clear: growth is moderating, but the economy is not falling off a cliff. The employment rebound adds a layer of complexity, but it also underscores the resilience of the US labor market. As always, investors should focus on diversification and avoid making knee-jerk reactions to any single data point.
