Rising oil prices are expected to drive a significant increase in the US Consumer Price Index (CPI) for March, with a projected year-on-year surge of 3.5%.
Recent data indicates that growth in the US services sector, the largest component of the American economy, slowed in March. This deceleration is attributed to heightened business costs resulting from conflict, prompting companies to reduce hiring. This suggests the US economy faces a more challenging path ahead until tensions ease, presenting the Federal Reserve with a dual challenge of managing inflation and employment.
The impact of Middle East hostilities is spreading. Data released on Monday by the Institute for Supply Management (ISM) showed the Services PMI, which covers sectors like banking, retail, and restaurants, fell to 54% in March from 56.1% in February. February's reading had been the highest in three and a half years.
Boosted by seasonal factors, the New Orders Index climbed to 60.6 from 58.6 in February, reaching a three-year high. On the negative side, the Prices Paid Index soared to its highest level since October 2022, recording its largest monthly increase in 13 years. Costs for oil, fertilizer, and other key chemicals rose significantly due to partial closures of the critical Hormuz Strait shipping channel along the Iranian coast.
Businesses responded by controlling hiring or leaving positions unfilled. The Employment Index contracted for the first time in four months, contrasting sharply with the substantial job growth shown in the official US employment report for March.
Geopolitical conflict in the Middle East was a central theme in comments within the ISM report. Companies across various industries, from construction to wholesale trade, noted that the conflict has added a layer of extra uncertainty. Even before the outbreak of war, businesses were grappling with uncertainties related to import tariffs.
However, any reading above 50% indicates the sector is still expanding. The index has remained above this key threshold for 21 consecutive months. Looking ahead, the renewed strength in new orders suggests the massive services economy may continue expanding at an above-average pace, supported by stable domestic US sales. Over 80% of Americans are employed by service-sector firms. The services sector is relatively less affected by global crises as its operations are predominantly domestic.
It is worth noting that data released last Friday by S&P Global also showed the US Services PMI fell to 49.8 in March from 51.7 in February, dropping into contraction territory for the first time since January 2023 and well below a preliminary estimate of 51.1. Alongside rising price pressures, employment saw a slight decline for the first time since December, reflecting business caution about the outlook. "The service sector dragged the overall rate of economic growth down to a near-stagnation in March, measured at an annualized rate of 0.5%. The consumer-facing segment was the hardest hit, recording one of the largest declines since 2009, excluding the pandemic lockdown months," said Chris Williamson, Chief Business Economist at S&P Global Market Intelligence.
The surveys released on Monday reinforced Wall Street expectations that the Federal Reserve will keep interest rates unchanged for an extended period. Pricing in federal funds rate futures suggests a potential window for rate cuts may not arrive until the second half of next year.
"The services sector is still expanding, but headwinds are mounting," said Priscilla Thiagamoorthy, Senior Economist at BMO Capital Markets. "With employment softening and inflationary pressures heating up again, the data points to slowing growth and stickier prices. This puts the Fed in a difficult position and reinforces the case for patience."
Hostilities have driven global oil prices up by over 50%. Starting last week, the national average retail gasoline price surpassed $4 per gallon for the first time in nearly four years. Economists anticipate the inflationary shock from the conflict will be evident in the March CPI report scheduled for release on Friday.
"In our view, the first-round pass-through of higher oil prices will be visible in the March data via motor fuel costs," BNP Paribas noted in a research previewing the CPI report. Consensus estimates project a 0.9% month-on-month increase for March CPI, accelerating the annual rate to 3.5%. Core CPI, which excludes food and energy, is expected to rise 0.3% monthly.
Notably, two Fed officials expressed concerns about prices in recent remarks last Wednesday. Cleveland Fed President Beth Hammack and Chicago Fed President Austan Goolsbee both indicated that the inflation problem is far more severe than issues in the job market. Against a backdrop of rising energy prices due to conflict and persistently sluggish labor market growth, their comments highlighted a stance supportive of tighter, rather than looser, monetary policy.
"Were it not for the March jobs data already in hand, the employment decline would be more concerning," said John Ryding, Chief Economic Advisor at Brean Capital. "The ISM Prices Paid index is a very useful indicator of inflation trends; this number should worry the Fed and is consistent with an inflation rate close to 4%."
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