US Service Sector Expansion: How Februarys Unexpected Growth and Rising Prices May Signal Inflation Ahead

The US service sector has shown unexpected resilience, with growth accelerating in February, according to the Institute for Supply Management (ISM). The nonmanufacturing purchasing managers index (PMI) climbed to 53.5, surpassing economists' forecasts of a dip to 52.6. This uptick in growth, combined with rising prices for inputs, may indicate that inflation is on the horizon.

A PMI reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of the US economy. The ISM associates a PMI reading above 49 over time with expansion in the overall economy. However, this growth is at odds with other economic indicators, such as consumer spending and homebuilding, which suggest a sharp slowdown in gross domestic product (GDP) this quarter. The Atlanta Fed is currently forecasting GDP to contract at a 2.8% annualized rate this quarter, a significant decline from the 2.3% pace in the fourth quarter.

The Trump administration's new tariffs on imports from Mexico, Canada, and China are expected to raise prices for a wide range of goods, from avocados to motor vehicles. Target CEO Brian Cornell has announced that the retail giant will increase prices on some seasonal grocery products, such as avocados from Mexico, in response to the tariffs. Economists estimate that these tariffs could increase the cost of goods per household by nearly $1,000 annually. The Federal Reserve has already paused its interest rate cuts due to concerns about the impact of tariffs on prices. As the trade war escalates, it is likely that price pressures will continue to rise, potentially leading to higher inflation.

As the US service sector continues to grow, albeit at a slower pace than expected, it is essential to monitor the impact of tariffs and trade tensions on the economy. The ISM survey's measure of prices paid for services inputs rose to 62.6 in February, indicating increasing price pressures. Suppliers' delivery performance also slowed, contributing to the rise in the services PMI. While a lengthening in suppliers' delivery times is normally associated with a strong economy, in this case, it likely indicates bottlenecks in supply chains related to tariffs. As the economic landscape continues to evolve, it is crucial to stay informed about the latest developments and their potential impact on the economy and inflation.