- The Institute for Supply Management services index fell 0.5 point to 54.9 in September, still comfortably in expansion territory above the 50 threshold. Services account for the large majority of US economic activity, making this the more consequential of the two ISM readings.
- Cost pressures grew by the most in more than four years. The prices paid measure for materials and services rose to 74, the highest since July 2022, after hitting a near one-year low in February just before the Iran war pushed fuel costs higher. A diffusion reading at that level means a large majority of firms are paying more.
- Demand has not weakened materially. New orders slipped 1.1 point to 59.8 but remain among the strongest readings of recent years, and order backlogs reached their highest since July 2022, indicating work is queued into the fourth quarter.
- Hiring is barely positive. The employment gauge ticked to 50.1, entering expansion for the first time since June, as firms balance solid demand against rising costs. Supplier delivery times were the longest since June, affected by tariffs and the Middle East conflict.
What Happened?
ISM attributes continued demand for services to resilient consumer spending, a stable job market and strong business investment, while noting that firms must contend with mounting costs and disrupted supply chains.
Why It Matters?
This is the most difficult combination the Federal Reserve could face, and it appears in the sector that matters most. Prices accelerating to a four-year high while new orders hold near multi-year highs and backlogs build is not an economy where demand is overheating and can be cooled. It is cost-push inflation arriving through fuel, tariffs and supply chains into a sector with intact demand. Interest rates work by suppressing demand, and demand is not the problem here, which means further tightening would damage activity without addressing the source of the price pressure. The same bind is visible in oil, where higher rates cannot increase supply, and in memory chips, where AI-driven shortages are raising consumer prices. Three separate supply-side channels are now feeding inflation simultaneously. The timing of the price move is clear from the data itself. The measure reached a near one-year low in February and sits at 74 now, so essentially the entire increase traces to the period following the start of the Iran war, compounded by tariffs. That is useful because it identifies what would need to change for inflation to ease, and it is not the funds rate. Markets have been reducing expectations of another increase this month on softer inflation data and a weak jobs report, and this print argues the other way. The employment reading reinforces the uncomfortable picture. At 50.1, services firms are essentially not adding staff while absorbing higher costs, which alongside a lacklustre jobs report describes a labour market softening at the same time prices rise. That is the combination that makes central banking difficult and portfolio construction harder, since neither duration nor equities perform well in it.
What Next?
Federal Reserve minutes on Wednesday will show how the committee weighed cost pressures against activity when it raised rates last month, and whether services inflation featured in that discussion. Watch the prices paid series next month, since a second consecutive reading near 74 would make it difficult to characterise this as transitory supply disruption. Order backlogs at a four-year high support activity into the fourth quarter but also mean firms have the pricing power to pass costs through, so watch whether that appears in consumer price data. The employment gauge is the series to follow for signs of genuine labour market deterioration, as a move back below 50 alongside elevated prices would be the clearest stagflationary signal yet. Any easing in fuel costs following the G7 release would relieve the largest single input.
Affected Tickers and Coins: ZN, ZB
Source: Bloomberg
