ISM: US Services Sector Swings Back into Growth in May from April’s Brief Contraction but More Firms Concerned About High Interest Rates

–ISM Services Index at 53.8 Vs. 49.4 in April, Well Above Median Forecast 50.7
–Business Activity Surges to 18-Month High in May After Plunging to Nearly 4-Year Low in April
–Prices Paid Index Eases Slightly but Remains High
–Employment Index Below 50 Neutral Line for 4th Straight Month

By Max Sato

(MaceNews) – Business activity in the U.S. services sector posted a sharp rebound in May, backed by new orders, after unexpectedly slipping into contraction to end 15 months of growth in April, but more firms are expressing concerns that high borrowing costs are hindering capital investment, according to the latest survey by the Institute for Supply Management released Wednesday.

The ISM index, which shows the directional change of economic activity, rose 4.4 percentage points to a nine-month high of 53.8 in May after falling 2.0 points to a 16-month low of 49.4 in April for a third straight monthly decline. The index came in much stronger than the median economist forecast of 50.7 and above its 12-month average of 52.5.

It is well above the recent lows of 41.7 hit in April 2020 and 40.1 in March 2009, the latter of which is the lowest since the inception of the Services PMI in 2008. But it also remains well below the record high of 67.1 reached in November 2021.

“The increase in the composite index in May is a result of notably higher business activity, faster new orders growth, slower supplier deliveries and despite the continued contraction in employment,” Anthony Nieves, chair of the ISM Services Business Survey Committee, said in a statement. “Survey respondents indicated that overall business is increasing, with growth rates continuing to vary by company and industry. Employment challenges remain, primarily attributed to difficulties in backfilling positions and controlling labor expenses.”

“The majority of respondents indicate that inflation and the current interest rates are an impediment to improving business conditions,” he said, adding the rate policy concern to the list as seen in the ISM May manufacturing survey released Monday.

Nieves told reporters that he expects the services sector to show “incremental growth” into the summer due to the holiday season and vacation time. But he also said more firms are expressing concerns about high interest rates that is preventing new investment in equipment.

“Higher interest rates are reducing capital investment and slowing down major facility upgrades,” a firm from the agriculture, forestry, fishing and hunting industry told the ISM.

A construction company also blamed high interest rates for slower business, saying, “Residential construction continues to struggle, with high mortgage rates on the for-sale side. Higher interest rates are driving up the cost of capital and making ‘build to rent’ projects harder to pencil.”

“General uncertainty regarding the U.S. Federal Reserve’s position on future interest rates and the current political environment is affecting consumer sentiment,” a firm from the professional, scientific & technical services category said.

Of the four sub-indexes that directly factor into the services PMI, the business activity index jumped 10.3 points to an 18-month high of 61.2 in May after plunging 6.5 points to a nearly four-year low of 50.9 in April, which was below 52.9 recorded in May and 53.3 in April 2023 and the lowest since 41.2 in May 2020, when the pandemic caused a global slump. 

The new orders index rose 1.9 points to 54.1 after falling 2.2 points to a 16-month low of 52.2. It is still below a recent high of 56.1 seen in February but indicates expansion for the 17th consecutive month.

The employment index showed contraction for the fourth month in a row. It rose 1.2 points to 47.1 in May after falling 2.6 points to a four-month low of 45.9 in April.

The supplier deliveries index — the only ISM index that is inversed — rose 4.2 points to 52.7 after rising 3.1 points to 48.5 in April and falling 3.5 points to a record low of 45.4 in March, which was the fastest deliveries since July 1997, when the ISM began tracking them. The index showed the first expansion in four months, indicating that supplier delivery performance was “slower” after being “faster.” A reading of above 50 indicates slower deliveries, which is typical as the economy improves and customer demand increases.

In January, deliveries were delayed by bad weather in some U.S. regions, the impact of attacks in the Red Sea, which prompted shipping firms to avoid the Suez Canal in Egypt, as well as congestion at the drought-hit Panama Canal, a key route for cargo going between Asia and the U.S. East Coast.

In other details, the inventories index showed growth for the second straight month but it fell 1.6 points to 52.1 after surging 8.1 points to 53.7 in April and falling 1.5 points to 45.6 in March, which was the lowest since 45.1 in December 2022.

The prices paid index remains elevated. It fell 1.1 points to 58.1 after rising 5.8 points to 59.2 in April and falling 5.2 points to a four-year low of 53.4 in March, which was the lowest since 50.4 in March 2020 and well below its record high of 83.8 hit in March 2022. The index has been above the neutral line of 50 for seven years since 49.6 in May 2017.

The index for backlog orders, which is tied directly to efficiency in the upstream of supply chains, edged down 0.3 point to 50.8 in May after rising 6.3 points to 51.1 in April, back in growth territory, after falling 5.5 points to 44.8 in March, which was the first contraction in three months. It is still above 40.9 in May 2023, which is the lowest since 46.4 in May 2009.

The new export orders index soared 13.9 points to an eight-month high of 61.8 in May after slipping 4.8 points to a six-month low of 47.9 in April and rising 1.1 points to 52.7 in March.