US Service Sector Outlook 'Better Than Expected'... Will Fed Keep Rates Steady Throughout First Half?

ISM Service Sector PMI at 54.1 in December Last Year
Service Sector Price Index Hits Highest in 2 Years
10-Year Treasury Yield Threatens 4.7% Amid Inflation Concerns

The U.S. service sector economy has continued to show stronger-than-expected momentum. As concerns over inflation, which had recently rebounded slightly due to the robust U.S. economy, reignite, speculation is spreading that the Federal Reserve (Fed) may keep interest rates unchanged in the first half of the year. The U.S. Treasury yield on the 10-year note surged to nearly 4.7%, reaching its highest level in about eight months, while the S&P 500 and Nasdaq indices on the New York Stock Exchange plunged 1.11% and 1.89%, respectively.

According to the U.S. Institute for Supply Management (ISM) on the 7th (local time), the service sector Purchasing Managers' Index (PMI) for December last year recorded 54.1. This exceeded both the previous month’s figure (52.1) and expert forecasts (53.5). A PMI above 50 indicates expansion, while below 50 indicates contraction, confirming that the service sector economy is continuing a stronger-than-expected expansion trend.

The service sector price index, a sub-index of the service PMI, rose from 58.2 in November to 64.4 in December. This not only surpassed market expectations (57.5) but also marked the highest level since early 2023. Among the 19 service industries, 15 reported increased prices paid. Steven Miller, chairman of ISM’s service sector survey committee, explained, "While there was general optimism across many industries, many respondents expressed concerns about tariffs."

Pantheon Macroeconomics analyzed, "This indicator suggests that service sector disinflation (a slowdown in price increases) is stalling."

Separately released job openings data also exceeded expectations. According to the U.S. Department of Labor’s Job Openings and Labor Turnover Survey (JOLTS), job openings in November last year totaled 8.1 million, surpassing both market forecasts (7.73 million) and October’s figure (7.84 million). This is the highest level in six months since May last year (8.23 million). However, a more accurate labor market picture is expected from the December employment report to be released on the 10th. The market expects nonfarm payrolls to have increased by 154,000 in December, down from 227,000 in the previous month. The unemployment rate is forecast to remain steady at 4.2%.

With the strong service sector performance repeatedly confirming the robust expansion of the U.S. economy, inflation concerns are also resurfacing. Raphael Bostic, president of the Federal Reserve Bank of Atlanta, in remarks recorded a month ago and released on this day, said that inflation is expected to decline toward 2%, but "given the bumps along the way, we need to be more cautious in our policy approach."

As speculation grows that the Fed will keep interest rates unchanged not only this month but through the first half of the year, Treasury yields are soaring. The U.S. 10-year Treasury yield, a global bond yield benchmark, rose 8 basis points (1bp = 0.01 percentage points) from the previous day to 4.69%, reaching its highest level in about eight months since late April last year. The yield on the more policy-sensitive 2-year Treasury note is moving at 4.29%, up 2 basis points.

The market is also increasing bets on rate-hold expectations. According to the Chicago Mercantile Exchange (CME) FedWatch tool, the federal funds futures market on this day priced in a 95.2% chance that the Fed will keep rates unchanged at the Federal Open Market Committee (FOMC) meeting scheduled for the 28th-29th. This is up from 90.4% a week ago. The likelihood of maintaining current rates through March and May stands at 60% and 50%, respectively, while the chance of holding rates steady through June exceeds 30%. All these probabilities have risen by about 10 percentage points compared to a week ago.

Tom Heinlein, senior investment strategist at U.S. Bank Asset Management Group, analyzed, "Inflation expectations and Fed rate outlooks are being recalibrated."

Bill Adams, chief economist at Comerica Bank, predicted, "It is highly likely that the Fed will shift from cutting rates between September and December last year to halting rate cuts in 2025."