Key Points

  • U.S. service sector activity expanded for a seventh consecutive month in January, but a decline in new service orders may reflect market concerns over risks from the Trump administration's tariffs and deportation plans.
  • Data released by the Institute for Supply Management (ISM) on Wednesday showed that its index tracking purchasing manager activity in the services sector fell to 52.8% last month, down from 54% in December, but still above the 50% threshold, indicating the industry remains in expansion territory. The U.S. services sector contributes approximately 76% to gross domestic product (GDP) growth.
  • Steve Miller, chair of the ISM Services Business Survey Committee, said in a statement that many respondents "mentioned preparations for or concerns about potential U.S. government tariff actions, but there was little mention of current business impacts from them."

Deeper Dive

U.S. President Donald Trump announced on Tuesday, after talks with the leaders of Mexico and Canada, that he would suspend the 25% tariffs on imports from both countries until March 4. On the same day, the Chinese government imposed retaliatory tariffs in response to Trump's 10% tariff on Chinese imports announced last week.

The ISM new orders index fell to a seven-month low, which Oliver Allen, senior U.S. economist at Pantheon Macroeconomics, noted in a report to clients "suggests that business concerns over the Trump administration's immigration and trade policies are outweighing optimism about the prospects for tax cuts or deregulation."

Allen said: "The composite index is currently at a level that, based on historical data, is consistent with modest growth in services activity." He also noted that the index has not accurately reflected actual consumer spending conditions in recent years.

ISM cited several monthly survey respondents who said they worry tariffs will trigger disruptions such as price increases and goods shortages. One services executive providing management and other support services to businesses told ISM: "Shareholders and suppliers have some concerns about changes in government policy and potential tariff burdens."

Federal Reserve policymakers paused monetary easing last month after cutting their key interest rate by a full percentage point cumulatively between September and December, partly because the impact of changes in U.S. economic policy, including the imposition of tariffs, remains unclear.

Fed Chair Jerome Powell said on January 29 after policymakers unanimously decided to hold the key rate in the 4.25% to 4.5% range: "In the current situation, given the policy shifts in the four areas I mentioned—tariffs, immigration, fiscal policy, and regulatory policy—there may be some elevated uncertainty. So you can only hold steady and wait for clarity to emerge."

Richmond Fed President Tom Barkin echoed Powell's remarks on Wednesday, reiterating that the central bank is likely to keep borrowing costs at current levels until the policy outlook becomes clearer. Barkin said in an interview with Bloomberg Television: "Looking ahead, you have to say tariffs are coming, or are here, or are about to come. Knowing exactly where it all ends up is extremely difficult."

Barkin said: "What I hear from everyone I talk to is a significant rise in policy uncertainty. You mentioned tariffs, but there's also deregulation—where will the impact land? How will the tax plan come together? What happens to net immigration? Energy policy? Geopolitics? I think there's a lot of uncertainty in the air right now, and until more of that uncertainty is resolved, it's hard to judge the path of growth, employment, and inflation."

Meanwhile, Powell, Barkin, and other Fed officials have recently said the U.S. economy is in good shape, the labor market is stable, and inflation is easing, albeit along a bumpy path. Fed Vice Chair Philip Jefferson said in a speech on Tuesday: "Overall, the U.S. economy is starting the new year on a good footing. I expect the gradual decline in inflation to continue, and I anticipate that economic growth and labor market conditions will remain solid."