ISM Services PMI Inches Up to 54.1, but Employment Slips into Contraction

Services PMI Holds Steady as Activity Accelerates

The US services sector continued its long expansion in July, with the Institute for Supply Management’s Services PMI reading of 54.1 marking a 0.1-point increase over June and the 25th consecutive month of faster growth. Any number above 50 indicates expansion, and the July print came in 0.7 points above the 12-month average of 53.4. The broader economy has now grown at an accelerating pace for 74 straight months.

Underneath the headline number, the report showed marked divergence among subindexes. The Business Activity/Production gauge surged 3.7 percentage points to 59.1, while New Orders rose 2.1 points to 57.2, the fourth-highest reading in 26 months. In contrast, the Employment index tumbled 3.8 points to 47.4, slipping into contraction territory for the fourth time in five months. Supplier Deliveries slowed again at 52.8, indicating some tightening but at a gentler pace.

Thirteen of the 17 service industries tracked reported growth, led by Retail Trade, Transportation & Warehousing, and Wholesale Trade. Four sectors contracted: Agriculture, Health Care, Real Estate, and Other Services. Panelists’ comments highlighted persistent pricing pressures, with fuel and labour costs driving increases, though overall demand remained stable and the outlook for the remainder of 2026 was described as favourable.

ISM Services Business Survey Committee Chair Steve Miller noted that the current stretch of solid PMI readings resembled the period in 2002 as the economy emerged from pandemic-related disruptions. He pointed to the employment-backlog relationship, suggesting that firms are managing high order volumes with existing staff—potentially through productivity improvements—and flagged petroleum prices, now roughly $20 per barrel above January levels, as a growing cost headwind.

What the Divergent PMI Signals Tell Us About the US Services Economy

Strong Demand Driven by Business Activity and New Orders

The July data underscores that demand for services remains robust. Business Activity hit 59.1, its highest level in months, with 13 sectors reporting gains, and New Orders’ 57.2 reading reflects a sustained appetite for services. The 12-month average for new orders has been climbing for over four months, suggesting broad-based confidence. For service providers in expanding industries, this signals a steady pipeline of work through year-end.

Employment Puzzle: Hiring Lag Despite Booming Orders

The 3.8-point drop in the Employment index stands out against the otherwise upbeat figures. ISM’s Miller linked this to the Backlog of Orders, reasoning that if companies can keep up with demand using current headcount, they don’t need to hire. He speculated that rising productivity—possibly aided by AI development—could be absorbing order volume that once required additional staff. This divergence points to an economy where service firms are finding ways to do more with less, a trend that could keep wage-driven inflation in check but also dampen job growth in the near term.

Rising Fuel and Labor Costs Pinch Margins

Panelist comments repeatedly cited higher fuel and labour costs, and Miller emphasised that petroleum prices remain significantly above their January levels. Transportation & Warehousing firms, despite expanding, are facing elevated operating expenses, while a Wholesale Trade respondent noted that builders are pushing back hard on price increases. The combination of strong demand and rising input costs creates a margin squeeze, particularly for fuel-intensive services, and suggests that service-sector inflation may remain sticky even as overall growth continues.

Strategic Implications for Businesses Amid Mixed Service Sector Data

• Transportation, warehousing and retail firms should prepare for sustained demand but actively manage fuel and labour expenses, which panelists flagged as rising significantly since January. The $20/barrel increase in oil prices directly pressures operating margins.
• With the employment index contracting while new orders remain near a 26-month high, efficiency gains appear to be absorbing labour needs. Companies may consider technology investments—such as AI-driven process automation—to maintain margins if hiring stays tight and order backlogs are under control.
• Sectors in contraction—agriculture, real estate, health care—are facing a different reality. Firms should re-evaluate cost structures and monitor whether their demand softens further, even as the overall services economy expands.