By Martin Baccardax

People watching the U.S. economy received a jolt of reality Wednesday through feedback from the men and women closest to its key growth engine, and from company bosses who manage the country's 170 million-strong workforce.

The message wasn't great. The latest data suggest slowing economic growth with the potential for faster inflation. It could be a toxic combination in that the inflation risk could make it harder for the Federal Reserve to lower rates to prop up the economy as it normally would.

Hiring is slowing, consumers are spending less, and costs are rising in the broadly defined services sector, which powers more than two-thirds of growth in gross domestic product.

The Institute for Supply Management's benchmark reading of business activity in May fell below the 50-point mark that separates growth from contraction for the first time in nearly a year. A reading of new orders, also in the report, slumped to 46.4, the lowest since December 2022.

Managers polled in the survey reported a spike in the prices they had to pay for components. While slowing demand might mean they are reluctant to pass those on to their customers, the fact that they are paying more still represents an inflationary risk.

An early read on employment, meanwhile, suggests some weakening on that front.

Payroll processing group ADP's National Employment report showed the softest private-sector hiring in two years, with 37,000 roles added in May. That said, salaries are holding up, with people remaining in jobs getting an average boost of 4.5% in wages and those landing a new role seeing gains of 7%.

Bill Adams, chief economist for Comerica Bank in Dallas, said the ADP numbers were weak, but not poor enough to persuade the Federal Reserve to lower interests rates in the short term.

"The job market has downshifted in the second quarter," he said. "The Fed will take notice, but labor force growth will be slower due to less immigration, so less job growth is needed to hold the unemployment rate steady."

Both the ISM reading and the ADP jobs numbers could highlight that the economy is in a difficult position in terms of monetary policy. Growth is slowing, but not enough to trigger a response, especially because there are underlying inflation pressures that have yet to materialize.

Oliver Allen, senior U.S. economist at Pantheon Macroeconomics, thinks it could all work out for the best, but only if companies opt not to pass on higher prices to their customers. That, he argues, would allow the Fed to "look through a passing surge in core goods inflation and focus on supporting activity and employment with looser monetary policy."

Traders are hedging their bets. The CME Group's FedWatch tool still puts the first Fed rate cut of the year in September, but pegs the odds of a quarter-point reduction at no more than 58%.

The next risk, argues Louis Navellier of Navellier Calculated Investing, is the worst of both worlds. "The follow-through concern is that a spike in inflation will impact spending and employment and lead to stagflation, " he said. "Currently, the market is dismissing that potential as it marches toward new highs."

The S&P 500, fresh off its best May performance since 1990, is less than 3% from the record closing high it notched on Feb. 19.

That is a contrast to the slump in CEO confidence, however, and suggests a disconnect will ultimately have to be solved. The Conference Board's most recent reading, published last week, showed the biggest quarterly decline in five decades and the lowest overall tally since 2022. Company bosses cited geopolitical instability, trade, and tariffs as their three biggest concerns.

The Atlanta Fed will update its GDPNow tracker, which currently estimates current-quarter growth at 4.6%, on Thursday. Both the ISM services data and ADP numbers will be factored in.

A weaker-than-expected jobs report from the Labor Department on Friday could stoke slowdown concerns even further.

Write to Martin Baccardax at martin.baccardax@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

June 04, 2025 16:33 ET (20:33 GMT)

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