For most of last year, the Federal Reserve was cautiously optimistic. Inflation had been grinding lower, the labour market was resilient, consumer spending remained steady, and the long-hoped-for soft landing seemed within reach. Then the U.S. and Israel launched military operations against Iran on February 28, and the economic picture changed almost overnight.
The March data from the Institute for Supply Management drives that point home with unusual force. The ISM’s nonmanufacturing Purchasing Managers’ Index — the broadest monthly snapshot of the U.S. service sector, which accounts for more than two-thirds of all economic activity — slipped to 54.0 from 56.1 in February, missing the 54.9 that economists polled by Reuters had expected. The service sector is still growing — any reading above 50 signals expansion — but the internals of the report tell a more concerning story: prices soaring, employment contracting, and businesses across a wide range of industries citing the Iran conflict as the dominant source of uncertainty in their operations.
It is, by any reasonable reading, the clearest evidence yet that a war 7,000 miles away has arrived squarely in the American economy.
The Price Surge That Commands Attention
The headline number matters, but it is the prices sub-index that has genuinely alarmed economists. The ISM’s measure of prices paid by businesses for inputs soared 7.7 percentage points to 70.7 — the highest reading since October 2022, and the single largest monthly jump in nearly 14 years. To put that in context: the last time the monthly increase in the prices index was this large, the U.S. economy was navigating the inflationary aftermath of Russia’s invasion of Ukraine and pandemic-era supply chain dislocations.
The gauge has now remained above 60 for 16 consecutive months, indicating sustained and persistent cost pressure on the service sector. Crucially, in the March report, not a single commodity was reported as declining in price across the entire survey. The culprit is unmistakable: fuel. The closure of the Strait of Hormuz — through which roughly one-fifth of the world’s oil and natural gas normally flows — since early March has sent energy costs surging across every segment of the economy. The national average retail gasoline price has climbed above $4 a gallon for the first time in nearly four years. Airlines are paying dramatically higher fuel costs. Trucking companies are passing on surcharges. Logistics chains are extending delivery times and charging premiums for speed and reliability.
Transportation and warehousing firms reported significantly higher operational costs. Wholesale trade businesses specifically called out rising war-risk surcharges in the Strait of Hormuz, noting that “landed costs have increased materially — even for air freight.” Real estate and leasing companies described the war as “an additional layer of uncertainty on top of an already shaky macroeconomic climate.” Mining companies cited reduced international business due to “political uncertainty with Iran conflict.” Construction firms reported force majeure notifications from Middle Eastern suppliers.
The breadth of that commentary — spanning industries from accommodation and food services to professional services to utilities — suggests the price pressure is not confined to one corner of the economy. It is spreading.
The Employment Contradiction
One of the more puzzling features of the March ISM data is the employment sub-index. The services jobs measure dropped sharply to 45.2, the lowest since December 2023 — well below the 50 threshold that separates expansion from contraction. In isolation, that number would be alarming, suggesting the service sector is actively shedding workers or at minimum freezing hiring.
But it sits in tension with the broader labour market picture. The government’s official jobs report released the previous Friday showed a sharp rebound in job growth, driven by a 143,000 increase in private service-providing payrolls. The ISM survey and official government data are measuring slightly different things, and the sharp divergence in a single month likely reflects business-level sentiment responding to uncertainty rather than actual widespread layoffs. Put simply: companies may be pausing hiring plans and feeling anxious, even as the aggregate job numbers hold up reasonably well.
Priscilla Thiagamoorthy, a senior economist at BMO Capital Markets, captured the picture succinctly: “The service sector is still expanding, but headwinds are picking up. With employment softening and inflation pressures flaring up again, the data suggest slower growth alongside sticky price pressures. This keeps the Fed in a difficult position and reinforces the case for patience.”
That last phrase — “the case for patience” — has become the central message coming from economists watching the data. The Fed held its benchmark rate at 3.50% to 3.75% at its March meeting, and the March ISM data strongly reinforces the view that rate cuts will not be arriving anytime soon.
Double Headwind: War and Tariffs
What makes the current environment particularly difficult to navigate is that American businesses were already under pressure from tariff uncertainty before the Iran conflict began. Several survey respondents noted that they had spent months managing uncertainty around import duties, only to find a second, more acute layer of uncertainty added on top.
The ISM data showed ISM’s supplier delivery index rising to 56.2 from 53.9, consistent with slowing deliveries — the 16th consecutive month of that trend. Businesses are stockpiling in response. ISM respondents described “purchasing additional inventory to account for geopolitical issues” and “stockpiling oil-derivative products in case the extended conflict in Iran or closure of the Strait of Hormuz cause supply issues.” This kind of precautionary inventory build typically amplifies demand signals in the near term, inflating order numbers — the new orders index rose to a two-year high of 60.6 — while masking the underlying caution that businesses are feeling about the months ahead.
What It Means for the Fed — and for Everyone Else
The March services PMI report lands in the middle of a fraught debate about how the Federal Reserve should respond to an oil-shock-driven inflation surge. The orthodox view — supported by many mainstream economists — is that the Fed should look through supply-driven energy price spikes, since raising rates cannot reopen the Strait of Hormuz or bring down oil prices. Rate hikes would hurt growth without addressing the actual source of inflation.
But the data is making that argument harder to sustain politically and practically. The March CPI data — released after this ISM survey — came in at 3.3% year-on-year, well above target. Producer prices had already surged in February in anticipation of the conflict’s escalation. And if the 70.7 prices reading in the ISM service sector persists or intensifies, the risk is that energy-driven cost pressures begin bleeding into wages and broader price-setting behaviour — the kind of second-round effects that make inflation genuinely sticky.
The ISM’s Steve Miller, chair of the Services Business Survey Committee, was careful to note that despite the warning signs, the service sector should “remain durable.” The economy is still expanding — for the 70th consecutive month overall, and the 21st consecutive month in service-sector expansion. But the trajectory has shifted. The current Services PMI of 54 corresponds to approximately 1.9% annualised real GDP growth, down from the 2.5% implied by February’s reading.
In the space of four weeks, the Iran war has gone from a geopolitical event happening somewhere far away to a measurable drag on American economic momentum, a measurable lift in American business costs, and a measurable constraint on the Federal Reserve’s ability to ease policy. The data is in. The war’s economic bill has begun arriving at the door.
Written by Shalin Soni, CMA specializing in financial analysis, global markets, and corporate strategy, with hands-on experience in financial planning and analytical decision-making.
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Source: Based on Reuters and publicly available information.
Disclaimer
This article is based on publicly available information, market developments, and credible media reports. The content is intended for informational and analytical purposes only and should not be considered financial, investment, or legal advice.