• Topline ISM Services Purchasing Managers Index (PMI) composite fell to 56.5, lowest since November 2020
• The ISM Services Employment component index fell to 48.5, breaking through the expansionary threshold of 50
• Backlog of Orders for services (i.e., travel, education in the U.S.) bounces after three-month improvement
• The ISM Services Prices component rose in February, signaling continued wage and inflation pressures
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The ISM (Institute for Supply Management) Services PMI fell to 56.5 in February 2022. The ISM indices measure net expansion across measured categories, with 50 representing the threshold between advances and contraction. Although the February 2022 reading remains above that expansionary threshold, it has fallen from a peak of 68.4 in November 2021, and after remaining at a plateau of around 65 throughout last year. COVID-19 effects on U.S. economic activity have been felt most acutely among services-oriented businesses often driven by in-person interaction. Turning the corner on the detrimental impact of the virus on services businesses entering the second quarter of the year seems a necessary component in halting the sector’s current slide.

Consumer sentiment measures have fallen to start the new year, which is clearly translating into less spending at service-oriented businesses. The Business Activity component of the ISM Services Index fell to 55.1 in February 2022 – its lowest reading since May 2020. This component reveals a dramatic reversal of service industry trends experienced through the second half of 2021. A peak of 72.5 was reached in November 2021, which was the result of a steady climb throughout the year from February 2021’s 56.8 reading. This component is seasonally adjusted, so natural weakness during winter months does not provide a satisfying explanation for the sharp declines over the past three months. Consumer price inflation is affecting the cost of living for even necessities, such as food, housing costs and gasoline (the latter to yield even greater upward pressure in the months to come). As such, households may be forced to cut discretionary spending at leisure & hospitality businesses, potentially extending ISM Services Index declines into mid-year.

The Employment subcomponent of the overall index fell to 48.5, breaking below the expansionary threshold of 50 for the first time since June 2021 (49.7). The February 2022 reading is, in fact, the weakest result posted since August 2020 (47.6; 48.6 in December 2020), and is the third consecutive decline for this index component. It is well-established that services businesses continue to have difficulty finding workers, despite raising wages at an unprecedented pace for the sector. With consumer price inflation continuing to rise at rates not seen in 40 years, wage pressures will likely remain a hurdle for service providers to clear en route toward re-establishing full operational capacity, especially as warmer weather approaches for much of the nation and consumer spending on services ramps up.

The ISM Services component index measuring Prices faced by service-oriented businesses posted its fifth consecutive 80+ reading in February 2022 (83.1; all-time high of 83.9 in December 2021). Wage increases are a major contributor for such businesses, but costs are indeed rising on all fronts, adding to the balancing act performed by businesses such as restaurants which are still battling to regain customer volume exiting the worst of the pandemic’s effects on demand. Thus far, consumer price inflation has not dented personal consumption expenditures across the U.S. economy. But the Prices component of the ISM Services Index suggests that that trend will be put to the test as 2022 wears on and a switch in household spending preferences from goods to ever-higher-priced services takes hold.

The Backlog of Orders component of the ISM Services Index rose to 64.2 in February 2022, regaining a 60-handle after dipping below that mark in January for the first time since early 2021 (55.7 in April). Service-providing businesses may be facing the repercussions of resource-constraints and the backlog of orders created. New Orders slowed in February for the fourth consecutive month (56.1, down from 69.0 in October 2021) – an indication of near-term demand – which coincides with the slowdown in current-conditions indicators of Business Activity discussed above.

Service providers will have to work to catch up on existing customers’ orders to avoid the reputational risk of delays compounding the operational difficulties presented by higher prices and resource/labor constraints. Despite seeming improvements on the COVID-19 front, services businesses face a difficult operating environment in the coming months, and the ISM Services Index will struggle to remain above the expansionary threshold of 50 overall.

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