After a brief decline in December, U.S. service sector economic activity rebounded strongly in January 2023, offering a glimmer of hope for the market. The latest Services Business Report from the Institute for Supply Management (ISM) provides a detailed picture of this recovery. This article will analyze the report, examine its driving factors, and explore future trends.
Service Sector PMI: Back in Expansion Territory
The Services Purchasing Managers' Index (PMI) is a key indicator of service sector activity. A reading above 50 indicates expansion, while below 50 signals contraction. The January PMI reached 55.2, a significant 6.0-point increase from December's 49.2, marking a return to expansion territory. Notably, December's PMI had fallen 6.9 points from November's 55.5, ending a 30-month growth streak. Prior to December's contraction, the U.S. service sector PMI had shown growth in 152 of the past 154 months, demonstrating remarkable resilience.
Despite January's strong performance, the PMI remains slightly below the 12-month average of 55.7. Over this period, the index peaked at 58.4 in March 2022 and bottomed at 49.2 in December 2022, reflecting how macroeconomic uncertainty has impacted the service sector.
Sector Performance: Mixed Results
The ISM report shows that 10 of the 18 tracked service industries expanded in January:
- Agriculture, forestry, fishing and hunting
- Utilities
- Other services
- Management of companies and support services
- Public administration
- Educational services
- Accommodation and food services
- Real estate, rental and leasing
- Health care and social assistance
- Professional, scientific and technical services
Conversely, eight industries contracted:
- Transportation and warehousing
- Retail trade
- Arts, entertainment and recreation
- Mining
- Construction
- Information
- Finance and insurance
- Wholesale trade
This mixed performance highlights how different service industries respond differently to macroeconomic conditions. Some sectors like health care and social assistance demonstrate greater resilience during economic downturns, while others like transportation and warehousing are more sensitive to economic fluctuations.
Component Indices: Broad-Based Improvement
The services PMI is calculated from several component indices that reflect different aspects of service sector activity. In January, most components showed improvement from December, indicating a comprehensive recovery.
Business Activity/Production Index: At 60.4, up 6.9 points from December, this index has now grown for 32 consecutive months, with accelerating expansion. Eleven industries reported growth, signaling increased production activity.
New Orders Index: Jumping 15.2 points to 60.4, this index reversed December's contraction. Eleven industries reported new order growth, suggesting sustained demand for services.
Employment Index: At the neutral 50.0 mark (up 0.6 points), this index moved out of contraction territory. Eight industries reported employment gains, indicating gradual labor market improvement.
Backlog of Orders Index: Rising 1.4 points to 52.9, this index has expanded for 25 consecutive months. Nine industries reported increased backlogs, showing some order pressure.
Supplier Deliveries Index: At 50.0 (up 1.5 points), this reading suggests stable delivery times. Six industries reported slower deliveries, indicating lingering supply chain bottlenecks.
Prices Index: Although down 2.8 points to 67.8, this index has grown for 68 straight months. Fifteen industries reported price increases, showing persistent (though moderating) inflationary pressures.
Industry Perspectives
The ISM report includes comments from service sector business representatives that reflect current economic sentiment.
An information services respondent noted: "While uncertainty persists, there's consensus that supply chain issues are easing. We're cautiously optimistic about 2023 but recognize challenges remain."
A retail trade representative observed that after the holiday season, supply chains are consolidating with improved capacity compared to previous periods.
Tony Nieves, Chair of the ISM Services Business Survey Committee, identified robust new orders and business activity as January's key growth drivers. "Employment and supplier delivery indices also stabilized, moving out of contraction without further decline," he added.
Regarding employment, Nieves clarified that the report doesn't measure actual job creation. Instead, it surveys 18 service industries about their employment situations, weighted by their GDP contributions. "Some sectors like real estate leasing and information services aren't currently adding jobs," he noted.
Looking ahead, Nieves expects the services PMI to stabilize around 55. "We'll likely see new orders and business activity decline while supplier deliveries slow. Employment may hover near 50. Overall, I'd predict a range of 53-54."
On inflation, Nieves acknowledged the Federal Reserve's interest rate actions aim to curb high inflation while affecting the housing market—GDP's largest contributor. "Rents are rising, and while some cities show slowing leasing activity, the national rental market remains strong."
Analysis and Outlook
Several key conclusions emerge from this data:
- Service sector recovery: January's strong PMI rebound indicates the sector is recovering from December's brief contraction, boosting confidence in broader economic recovery.
- Sector divergence: Different industries' varied responses to macroeconomic conditions suggest the need for targeted policy measures.
- Persistent supply chain issues: The supplier deliveries index suggests ongoing bottlenecks that could affect production and delivery.
- Inflation concerns remain: Although moderating, price pressures persist, with Federal Reserve policy playing a crucial role.
- Potential growth slowdown: Nieves' projections suggest possible deceleration in new orders, business activity, and employment growth.
Economic Implications and Policy Considerations
As a vital component of the U.S. economy, the service sector's performance significantly impacts overall economic health. Its recovery could stimulate growth, create jobs, and stabilize market confidence.
To support sustained recovery and development, several policy approaches merit consideration:
- Addressing supply chain bottlenecks through infrastructure investment
- Implementing balanced monetary policy to control inflation without excessive growth constraints
- Supporting service sector innovation and technological upgrades
- Optimizing the business environment to reduce operational costs
- Enhancing workforce training to meet evolving service sector needs
Conclusion
January's strong service sector rebound offers hope for economic recovery, but challenges persist, and growth may moderate. Effective policies can promote sustained recovery and development, laying foundations for long-term prosperity. Monitoring PMI trends and component indices will remain crucial for understanding sector dynamics and adjusting policies to address emerging risks. Simultaneously, global economic conditions and international service sector developments warrant attention to identify opportunities and navigate challenges toward sustainable growth.
Ultimately, the U.S. service sector's recovery path won't be smooth, requiring concerted efforts to overcome obstacles and achieve a more prosperous future.