U.S. services sector activity accelerates sharply in August, S&P Global says

The US private sector entered the third quarter at its fastest pace in months, according to preliminary data released Thursday, even as American factories fell back into contraction for the first time since late 2025 — a divergence that delivers a complicated message to Federal Reserve Chair Kevin Warsh just five days before he chairs the FOMC's July 28–29 rate decision.

S&P Global's July flash Composite PMI came in at 54.6, up sharply from June's reading of 52.9. The number lands above the 50-point threshold that separates expansion from contraction and maps, by S&P Global's own regression model, to an annualized GDP growth rate of roughly 2.3% — a significant step up from the 1.3% the same survey implied for the second quarter.

"The flash PMI data indicated that the US economy grew at a sharply increased rate at the start of the third quarter, consistent with the economy expanding at a 2.3% annualized rate," said Chris Williamson, Chief Business Economist at S&P Global Market Intelligence. "That represents a marked improvement on the 1.3% rate signalled by the survey for the second quarter."

The data also arrives on a day with significant trade policy stakes: the Section 122 tariff regime — the 15% across-the-board import surcharge the Trump administration imposed in February after the Supreme Court struck down its IEEPA tariff authority — expires today, July 24, 2026. What replaces it, if anything, remains legally unsettled.

How the PMI Works: Diffusion Index Basics

The Composite PMI is a diffusion index — a statistical device that measures not the level of economic activity but the direction and breadth of change across a surveying panel. Each month, S&P Global queries purchasing managers at roughly 800 private sector companies on five indicators: new orders, output, employment, supplier delivery times, and inventories.

For each question, respondents answer "higher," "same," or "lower" compared with the prior month. The index formula is P1 + (0.5 × P2), where P1 is the percentage of respondents reporting improvement and P2 is the percentage reporting no change. A reading of exactly 50.0 means as many respondents reported improvement as reported deterioration. Readings above 50 signal expansion; below 50, contraction.

One counterintuitive feature of the manufacturing sub-index deserves attention: supplier delivery times are inverted. Slower deliveries — a sign that factories are under capacity pressure and demand is outpacing supply — are treated as a positive signal, boosting the index. When demand softens, as it has now, deliveries speed up, dragging the manufacturing PMI lower through a second channel beyond weakening orders and output. That mechanical property means manufacturing PMIs tend to fall faster in demand-driven downturns than the raw underlying deterioration might suggest.

Thursday's flash is also preliminary. It incorporates roughly 80% of the panel's responses, released ahead of the month's end to provide an early read. The final July PMI will be published on the first business day of August, and revisions can be substantial: June's flash manufacturing PMI of 55.7 was revised sharply down to 53.9 in the final reading, suggesting today's 49.5 could shift meaningfully in either direction.

Services at 55.2: Spending on Experiences, Not Goods

The Services Business Activity Index surged to 55.2 from 52.9 in June — the strongest reading in several quarters. Consumer-facing industries, professional services, and technology-adjacent business services all registered solid gains, with services firms reporting improved hiring alongside sustained demand.

The pattern is consistent with a US economy that has structurally reoriented toward domestic consumption and white-collar output. With the labor market still relatively tight and real wages positive, households appear to be spending freely on experiences, financial services, and professional services — the categories that dominate the services basket. Williamson noted ahead of July's data that sustained services growth had been "accompanied by elevated price pressures" — language that will draw scrutiny at the Eccles Building next week.

For equity investors, the services reading presents a favorable backdrop in healthcare services, software, financial services, and consumer discretionary — sectors insulated from the direct import cost pressures squeezing their counterparts on the factory floor.

Manufacturing at 49.5: Two Headwinds, One Expired Lifeline

The Manufacturing PMI fell to 49.5 in July — the first sub-50 reading in months and a sharp reversal from June's final reading of 53.9. Factory managers reported softening new orders, a drawdown in precautionary inventories built earlier in the year, and continued hesitancy from clients wary of input cost increases.

The inventory drawdown is the structural explanation for the reversal. American manufacturers spent much of late Q1 and Q2 aggressively front-loading imports ahead of tariff uncertainty — first during the US-China truce's 90-day window in May, and then ahead of the Section 122 expiration — boosting PMI readings even as underlying demand remained uncertain. That pre-buying impulse has now exhausted itself, and new orders are settling at levels that reflect actual end-demand rather than precautionary accumulation.

Today's tariff expiration makes the forward picture more uncertain, not less. The Section 122 15% surcharge took effect February 24, 2026, under presidential proclamation, with a statutory 150-day ceiling. It expires today. The US Court of International Trade also ruled the tariff invalid in May in Oregon v. United States — though the government appealed and the remedy applied only to the three plaintiffs before the court. What tariff authority, if any, replaces the Section 122 regime as of tonight is not yet publicly declared. Section 232 and Section 301 tariffs survive separately, but those cover targeted industries rather than the broad import base the Section 122 surcharge addressed.

This policy vacuum is not merely background context. It is the decisive variable for manufacturing input costs in Q3. A factory manager placing orders today for October production cannot price their landed cost of imported inputs with any confidence.

Section 122 Expiration Today: What the Tariff Cliff Means for Q3 Supply Chains

Ocean freight rates have remained punishing throughout the peak season. As of early July, transpacific spot rates were running at approximately $6,200 per FEU to the West Coast and $8,000 per FEU to the East Coast — up more than 85% and 120% respectively from mid-May levels, driven by strong demand, blank sailings, and the COSCO July 1 General Rate Increase of $2,400 or more per FEU. Commodities including copper, aluminum, and steel remain costly from layered existing tariff premiums — Section 232 steel and aluminum duties remain in effect regardless of what happens with Section 122.

The practical result for importers is that the per-unit landed cost of bringing goods to US shores has risen sharply even before tariff premiums are layered on. The Section 122 expiration today removes one element of that cost stack — but whether the administration reimplements a replacement mechanism using another statutory authority, and at what rate, will determine whether the cost relief is real or transitory.

Read more: Iran Oil Shock Spills Into Demand Inflation, Lifting Fed Rate-Hike Odds to 73% by September

What the PMI Means for the FOMC Meeting Five Days Away

The Composite PMI reading of 54.6 arrives as the single most consequential piece of economic data before the FOMC concludes its July 28–29 session. Chair Kevin Warsh — who was sworn in May 22 and has chaired just one FOMC meeting — enters the July session with a Federal Open Market Committee already tilted hawkish.

At June's meeting, the vote was unanimous to hold the federal funds rate at its current target range of 3.50%–3.75%. The dot plot — the Summary of Economic Projections' grid of individual rate forecasts — shifted the median year-end 2026 federal funds rate forecast to 3.8%, implying at least one 25-basis-point hike before December. Nine of the 18 officials who submitted projections penciled in at least one hike. Warsh himself declined to submit a projection.

Since June, the picture has been volatile. The June consumer price index came in at 3.5% year-over-year, released by the Bureau of Labor Statistics on July 14 — below the 3.8% Wall Street had expected. That disinflationary data briefly knocked July hike probabilities to roughly 16%. But oil prices re-accelerated after the brief relief, and Fed Governor Lisa Cook, in a July 15 speech at the Exchequer Club, said the Fed's preferred measure of inflation — Personal Consumption Expenditures — was still running around 3.7% over the prior year, well above the 2% target, and that she was "prepared to raise rates if the expected disinflation does not appear in a timely manner." Governor Christopher Waller added on July 13 that it would take several months of positive readings to convince him inflation was returning to target.

By the morning of July 23, markets were pricing approximately a one-in-three probability of a rate hike at the July 28–29 meeting itself, with a much higher implied probability — around 73% by some estimates — for September. A composite PMI of 54.6 gives hawkish committee members exactly the argument they need: the economy is not slowing enough to justify patience.

Dollar and Bond Market Reaction

Currency markets responded swiftly to Thursday's data. The US Dollar Index rebounded toward the 97.30–97.40 range following the release, recovering from several sessions of weakness driven by geopolitical uncertainty around the US-Iran conflict and its effect on energy prices. The dollar had been under pressure as elevated Brent crude prices fed inflation concerns while simultaneously clouding the growth outlook.

Treasury yields, which had already drifted higher since June as rate hike expectations repriced and geopolitical risk premiums built, face additional upward pressure if the GDP-consistent acceleration in the composite PMI is sustained. The 2-year Treasury yield was running near 4% ahead of the PMI release — 25 basis points above the upper end of the current Fed funds target range — suggesting bond markets were already pricing a hike before Thursday's data.

Sector and Earnings Implications for Q3

The manufacturing-services divergence sets up a nuanced earnings season backdrop. Industrial companies, equipment manufacturers, and businesses exposed to global trade flows face tangible headwinds: weakening new orders, elevated input costs, and a front-loading effect that inflated prior-quarter revenues without building durable demand. Sectors most exposed to broad tariff environments — metals, electronics, auto components — are likely to see guidance revised lower as factories confirm the PMI's demand signals.

Service-sector companies operate in a more favorable environment. Financial services, healthcare services, software, and consumer discretionary are positioned to benefit from continued domestic spending momentum. The divergence in PMI sub-indices will likely map closely onto the divergence in Q2 earnings results and Q3 guidance across these categories. Any investor whose allocation strategy assumed the manufacturing resurgence of early 2026 would continue into the second half should weigh Thursday's reading against that assumption.

US Economy at a Policy Crossroads

The July flash PMI is simultaneously a growth signal and a complication. Growth is accelerating in the sectors that serve American consumers directly. The services engine — the bulk of the US private sector by employment and output — is expanding at a rate that is, by any historical standard, solid. But the factory floor is contracting, caught between exhausted front-loading demand and an import cost environment that remains difficult even as the Section 122 tariff regime expires today without a confirmed successor.

That divergence puts the Federal Reserve in a position it has occupied for much of 2026: a consumer-driven acceleration that raises inflationary pressure coexists with a manufacturing softening that raises growth risk. Standard monetary tools cannot resolve that tension — they can only make one side of it worse. A rate hike to contain the services-driven price pressure further squeezes already-contracting manufacturers whose biggest problem is not excess demand but import cost uncertainty.

What the Fed decides on July 29 will depend on data it does not yet have — the June PCE deflator, which will be released before the meeting concludes, and whatever the oil market does between now and then. Thursday's PMI gives Warsh both a reason to hold (manufacturing is already contracting) and a reason to move (services expansion is running hot enough that a 54.6 composite is inconsistent with an imminent easing). Investors and households will have their answer Wednesday.

Frequently Asked Questions

What does a PMI reading of 54.6 mean for the US economy?

A composite PMI of 54.6 means that roughly 54.6% more of the surveyed purchasing managers reported improving conditions than reported deteriorating ones — a net diffusion that S&P Global's regression model maps to annualized GDP growth of approximately 2.3%. The 50-point threshold is the dividing line between expansion and contraction; the distance above 50 reflects the breadth and pace of improvement across new orders, output, employment, supplier delivery times, and inventories. A 54.6 reading is meaningfully expansionary, though it is driven almost entirely by the services sector, since the manufacturing PMI simultaneously fell to 49.5 — itself a contraction signal.

Will the Federal Reserve raise rates at its July 28–29 meeting?

Markets were pricing roughly a one-in-three probability of a rate hike as of July 23, with the probability of a September hike considerably higher. The FOMC held rates steady at 3.50%–3.75% at its June meeting and the dot plot shifted to a 3.8% median year-end forecast, implying at least one hike before December. Thursday's PMI data, showing a sharper-than-expected composite acceleration, adds to the case for holding rather than easing but also introduces a complication: the manufacturing contraction signals a sector of the economy already under pressure. Chair Kevin Warsh has not publicly indicated his own rate preference and submitted no dot at June's meeting, according to Forbes July 23 reporting.

Why is manufacturing contracting when services are expanding so strongly?

The manufacturing sector spent much of Q1 and Q2 front-loading inventory purchases ahead of tariff uncertainty — first during the US-China truce's 90-day window and then ahead of the Section 122 tariff expiration on July 24. That pre-buying temporarily inflated manufacturing PMI readings without reflecting genuine end-demand. When the front-loading impulse exhausts itself, as it has now, new orders fall back to levels consistent with actual consumer demand rather than precautionary accumulation. The simultaneous expiration today of the Section 122 tariff regime — with no confirmed replacement mechanism — adds a forward cost-uncertainty layer that discourages new orders even further, since manufacturers cannot price their Q3 and Q4 import costs with any confidence, as detailed in Perkins Coie's Section 122 analysis.

What does the Section 122 tariff expiration mean for consumers and businesses?

Section 122 of the Trade Act of 1974 authorized the administration to impose a temporary 15% across-the-board import surcharge, which took effect February 24, 2026, following the Supreme Court's February 20 ruling that struck down the prior IEEPA tariff authority. The statutory limit under Section 122 is 150 days — which expires today. In principle, the removal of a 15% broad tariff could lower the landed cost of imported goods over time, providing some relief to both manufacturers and ultimately consumers. In practice, Section 232 and Section 301 tariffs remain in effect, ocean freight rates remain sharply elevated, and the administration has not yet announced what authority, if any, it will use to replace the Section 122 surcharge. Businesses should not assume a clean cost reduction until a replacement trade framework is either implemented or formally absent.