U.S. Services Sector Contracts for First Time in Nearly a Year, ISM Reports

The U.S. service sector contracted in May for the first time in almost 12 months, according to the Institute for Supply Management (ISM). The ISM services index slipped to 49.9% from April’s 51.6%, dipping below the 50% threshold that separates expansion from contraction. That decline signals a clear cooling across a wide range of service industries and raises fresh questions about near-term economic momentum.

Key Indicators Show Weakening Demand and Rising Costs

Several internal measures within the ISM report painted a concerning picture for service businesses. New orders collapsed to 46.4%, the lowest reading in more than three years, suggesting a marked pullback in customer demand that could translate into slower activity in coming months. Production barely registered growth, standing at 50.0%, which indicates output is essentially flat. Employment in the sector remained weak at 50.7%, hovering near neutral and pointing to only modest job gains if any.

At the same time, inflationary pressures within the services economy intensified. The ISM prices index jumped to 68.7%, the highest reading in roughly two and a half years, signaling that a larger share of firms reported rising input costs. For service firms, higher prices often reflect increased expenses for labor, fuel, transportation and other operating inputs rather than direct import costs, but those cost pressures can still squeeze profit margins and push firms to raise prices for customers.

Trade Tensions and Tariffs Continue to Weigh on Firms

Although many service companies have less direct exposure to imports and exports than manufacturers, ongoing trade disputes and tariff policies have nonetheless disrupted their businesses. Tariffs can raise the cost of goods and services used by service providers—such as parts, equipment and fuel—and create uncertainty that leads customers to delay purchases and projects. Business leaders in the ISM report voiced significant concern about the economic impact of tariffs. One transportation executive, for example, noted that recent tariff measures have increased operating costs.

Policymakers have taken some steps to ease pressure. The Trump administration eased certain tariffs in an effort to provide relief to affected sectors, but analysts warn that until trade tensions are fully resolved, tariffs and the threat of further escalation are likely to remain headwinds for growth. Uncertainty about trade policy can reduce investment and slow hiring as firms adopt a more cautious stance.

Why the ISM Reading Matters

The ISM services index is a diffusion measure that summarizes the breadth of activity across the services economy; readings above 50 indicate expansion while readings below 50 indicate contraction. Because services make up a large share of the U.S. economy, a downturn in this sector can have widespread implications for overall economic growth, employment and inflation. The steep drop in new orders is particularly notable because it often foreshadows weaker activity in future months.

Outlook and What to Watch Next

With new orders at multi-year lows and input price pressures rising, service firms face the dual challenge of softer demand and higher costs. How businesses respond—whether by trimming staff, delaying investments or passing costs to customers—will shape the near-term trajectory of hiring, inflation and output. Investors and policymakers will likely watch subsequent ISM reports and other monthly indicators for signs of stabilization or further deterioration, as well as any developments in trade negotiations that might reduce uncertainty and lower costs for businesses.

In the short term, the May ISM report highlights a services sector that is losing momentum and grappling with rising expenses. Until trade tensions are eased and demand recovers, businesses may remain cautious, with implications for growth across the broader economy.