U.S. business activity growth slowed to an 11-month low in March. The divergence in performance between the manufacturing and services sectors, combined with a significant resurgence in price pressures, has reignited market concerns about the risk of stagflation.
Preliminary data released on March 24th showed the U.S. Composite PMI Output Index fell to 51.4 in March, down from 51.9 in February, marking the lowest level since last April. The services sector was the primary drag, with its Business Activity Index dropping to 51.1, also an 11-month low. Conversely, the Manufacturing PMI rose to 52.4, reaching a two-month high.
A chief business economist at S&P Global Market Intelligence noted that the March PMI data sent mixed signals of "slowing growth and rising inflation." He indicated that additional uncertainty stemming from Middle East conflicts and cost-of-living pressures are dampening demand, while soaring energy prices and supply chain delays are driving up business costs. Price indicators from the survey suggest consumer price inflation could accelerate back to around 4%, hinting that the U.S. may be facing "stagflation" risks.
Following the data release, market expectations for the Federal Reserve's policy path became uncertain again. Weakness in the services sector, coupled with the first decline in the jobs market in over a year, could strengthen expectations for interest rate cuts. However, input costs and selling prices both hitting multi-month highs may constrain the scope for policy easing. Analysts generally believe the Fed will face a difficult balancing act between rising inflation risks and the risk of an economic slowdown.
The March PMI data revealed a clear divergence between sectors. Manufacturing performance was relatively robust: the Manufacturing PMI increased to 52.4 from 51.6 in February, marking the eighth consecutive month of expansion. The Output Index rose from 52.7 to 52.9, a two-month high. New order growth was the fastest in five months, and export orders stabilized after eight consecutive months of decline. Companies reported that the impact of tariffs on orders had diminished, and factories along with their clients were increasing safety stockpiles to lock in prices and ensure supply.
The services sector, however, showed clear signs of strain. The Services Business Activity Index fell to 51.1 from 51.7, the lowest since April last year. Weak new business growth, a faster decline in export orders, and low consumer and business confidence collectively restrained services expansion. Surveyed businesses widely attributed the slowdown to uncertainty caused by war and the suppressive effect of high interest rates on demand.
The resurgence of inflationary pressures was one of the most closely watched signals from the data. Average input costs rose sharply in March, with the rate of increase being the largest in ten months, primarily driven by war-induced energy price surges. These cost increases have been passed on to selling prices, with the average rate of charge inflation by businesses hitting the highest since August 2022.
Supplier delivery times in the manufacturing sector lengthened to the greatest extent since October 2022, reflecting renewed supply chain tensions. Businesses widely linked rising prices and tightening supplies directly to the Middle East conflict, citing issues like shipping delays and raw material shortages that are increasing operating costs.
The employment index recorded its first decline in over a year. Although the drop was modest, it marked the first contraction in staffing levels since February 2023, reflecting caution among businesses about hiring in an uncertain economic environment.
Manufacturing employment saw only a marginal increase, the weakest in eight months, while the services sector reported a drop in headcount. Companies generally stated that in response to cost pressures and demand uncertainty, they are seeking to cut expenses and control labor costs.
Business expectations for output over the next year showed significant divergence. The manufacturing expectations index rose to a 13-month high, as concerns about tariff impacts eased and firms anticipated stronger domestic demand for U.S.-made goods.
In contrast, expectations in the services sector fell to the weakest since last October. Service providers widely expressed concern about the impact of high energy prices on the cost of living, alongside worries about persistently high interest rates, financial market volatility, and travel disruptions.
The chief economist stated that the PMI data suggests an annualized GDP growth rate of just 1.0%, with overall economic expansion in the first quarter around 1.3%. He warned that the Fed will have to weigh the risks of rising inflation against the risk of the economy losing growth momentum, and that the ultimate policy direction will largely depend on the duration of the conflict and its impact on energy prices and global supply chains.