Demand Pressure is Waning

• The ISM Services PMI report fell to 54.4 in October 2022
• The Employment component reverted to a slight decline in October 2022, falling to 49.1
• The Commodity Prices component index, at 70.7 for October 2022, showed price pressures are still high for Service

The ISM Services PMI report came in at 54.4 for October 2022. The topline index is edging toward neutral after plateauing during the peak travel and services-spending season over the summer months. The ISM Services PMI index measures net activity among service industry businesses, with a reading of 50 implying an even split between those indicating expansionary and contractionary conditions. Household savings and growing credit card usage staved off a collapse in consumer demand while inflation ran rampant throughout mid-2022. But with pent-up demand from pandemic restrictions likely wearing thin, services-providing businesses will face a new demand reality entering 2023.

The Business Activity and New Orders component indices of the ISM Services PMI report both eased sharply in October 2022. The Business Activity subindex fell to 55.7, from 59.1 in September. And while still above the break-even threshold of 50 for the index, the pace of business activity among service providers is clearly softening. The Business Activity subindex posted results near 70 throughout the fourth quarter of 2021, demonstrating that seasonal factors influencing consumer spending habits can be overcome if sentiment and budgets allow. But inflation’s sting looks to finally have caught up with travel- & experience-starved consumers after the pandemic’s restrictions. The New Orders component index also eased, falling to 56.5 in October 2022 from 60.6 in the month prior. Service-oriented businesses seem to have all the early warning that they need that a slowdown in demand is in progress, and expense and operational adjustments for 2023 may be necessary.

The ISM Employment component index fell to 49.1 in October 2022. This result comes on the heels of a spike to 53.0 in September but is aligned with the generally uninspiring results for this component of the overall ISM Services index since April 2022. Hiring has remained difficult for Leisure & Hospitality businesses, with anecdotal evidence of workers all too eager to move on to other opportunities in the sector given competitive wage offerings. Households’ holiday spending could prop up that pattern of behavior for a few more months, leaving employers unable to hire even if they want or need to in order to meet demand. But the first half of 2023 could look starkly different for the service industry workforce. Rather than seeing the ISM Services Employment component at sub-50 levels due to lack of worker availability, slower consumer demand may well put employers under less pressure to hire, and also tilt the scales back in their favor through reduced wage cost pressures.

Service providers’ costs continued to rise strongly in October 2022. The Prices component index of the ISM Services report increased for the month, rising to 70.7 from 68.7 in September. This result is well below the peak of 83.9 experienced in December 2021, and the readings of 80+ for this subindex all the way through June 2022. But services industries should be expected to see cost pressures ease with a lag versus production industries, as they are at the tail end of the supply chain – the last link of passing costs onto consumers. The ISM Manufacturing report’s Commodity Prices component index actually declined in the October 2022 report (46.6), showing that upstream costs are waning. Service industries should see less cost pressure of their own as this year comes to a close – and just in time, it seems, as overall services demand looks set to decline entering 2023.

The Federal Reserve indicated out of its November meeting that monetary policy tightening remains in full-throttle mode. While services demand looks to be weakening, the Fed remains focused upon consumer price pressures, even if they are the result of costs that are already facing organic retreat through falling demand and easing upstream cost pressures. But until households give in to the Fed’s “Demand Destruction” dictates and prices for services actually reflect weakening broader economic environment, the ISM Services Index seems unlikely to provide outright contradiction to the U.S. central bank’s monetary policy path.