US economy slowing heading into tariffs turbulence

By Lucia Mutikani

WASHINGTON (Reuters) -The U.S. services sector slowed to a nine-month low in March, backing expectations that economic growth likely stalled in the first quarter amid uncertainty caused by import tariffs.

The economic outlook was further dimmed by President Donald Trump unveiling on Wednesday a 10% minimum tariff on most goods imported into the U.S., sparking threats of retaliation and rattling global financial markets.

Fitch Ratings estimated the nation's tariff rate was now the highest in more than a century. Economists warned of higher inflation and possible job losses as households slash spending and businesses pull back on investment, potentially pushing the economy into recession. Business and consumer sentiment had already tanked before Trump's sweeping tariffs.

"This adverse trade news from the White House is an extreme external shock to the economy ... and so too is the need for being on high alert for signs of recession," said Christopher Rupkey, chief economist at FWDBONDS.?

The Institute for Supply Management (ISM) said on Thursday that its nonmanufacturing purchasing managers index (PMI) dropped to 50.8 last month, the lowest reading since June 2024, from 53.5 in February. Economists polled by Reuters had forecast the services PMI would ease to 53.

A PMI reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of the economy. The ISM associates a PMI reading above 49 over time with growth in the overall economy.?

"There has been a significant increase in the number of respondents reporting cost increases due to tariff activity," said Steve Miller, chair of the ISM Services Business Survey Committee. But Miller added "there was a close balance in near-term sentiment, between panelists with good outlooks and those seeing or expecting declines."

Ten industries, including wholesale trade, public administration as well as construction and retail trade, reported growth. Among those reporting contraction were information, educational services and healthcare and social assistance.

Comments from businesses were downbeat. Some construction businesses said they were already seeing the effects of import duties on aluminum imposed by Trump in March, adding that "these costs will be passed on to customers."?

Tariffs were also a problem for information businesses, while utilities companies said they expected "price increases in the near future due to tariffs." Public administration firms said deep government spending cuts and mass firings of federal workers were "negatively impacting our operations."

Trump sees tariffs as a tool to raise revenue to offset his promised tax cuts and to revive a long-declining U.S. industrial base, a view not shared by economists. But economists worry that Trump's tariffs blitz since returning to the White House in January could push the economy into recession, especially if the nation's trade partners retaliate with duties of their own.

Gross domestic product estimates for the first quarter are below a 0.5% annualized rate, with high odds of a contraction.

That fear was underscored by other data from the Commerce Department's Bureau of Economic Analysis showing imports were unchanged at lofty levels in February, with imports of consumer goods hitting a record high as businesses rushed in cellphones and other household goods as well as pharmaceutical preparations.?

Imports of capital goods also were at an all-time high amid increases in computers and medical equipment. The rises were offset by declines in imports of finished metal shapes and non-monetary gold. The trade deficit contracted 6.1% to $122.7 billion from a record $130.7 billion in January.?

Trade was on track to significantly subtract from GDP. The economy grew at a 2.4% pace in the fourth quarter.?

"Clearly, firms continued to buy and hoard imports ahead of the imposition of tariffs," said Eugenio Aleman, chief economist at Raymond James. "We suspect this trend to continue in March, especially after yesterday's announcement of much larger tariffs on the rest of the world."

Stocks on Wall Street plunged. The dollar tumbled against a basket of currencies. U.S. Treasury yields fell.

ORDERS TEPID

The ISM survey's new orders measure dropped to 50.4 last month from 52.2 in February. With growth almost stalling, the survey's measure of prices paid for services inputs fell to a still-high 60.9 from 62.6 in February.?

Diminishing demand for services could constrain businesses' ability to raise prices. Goods prices, however, are likely to continue rising as tariffs snarl supply chains, boosting inflation.?

"At a minimum, the trade shock can be translated into a $410 billion tax on American households and businesses at a cost of $3,585 per household," said Joseph Brusuelas, chief economist at?

RSM US.

The survey's measure of services employment contracted for the first time in six months, likely foreshadowing labor market weakness. For now, the labor market remains stable, though laid-off workers are experiencing long bouts of unemployment.

A separate report from the Labor Department showed initial claims for state unemployment benefits dropped 6,000 to a seasonally adjusted 219,000 for the week ended March 29.?

Low layoffs have kept the labor market humming, but import duties and the Trump administration's unprecedented campaign to drastically shrink government pose a downside risk.

Mass firings of federal workers are yet to significantly show up in a subset of the claims report amid ongoing legal battles.?

But global outplacement firm Challenger, Gray & Christmas said on Thursday that it had over the past two months tracked 280,253 planned layoffs of federal workers and contractors impacting 27 agencies. It said more than half of the 497,052 layoffs announced in the first quarter were in Washington, D.C.

New jobs are scarce. The number of people receiving benefits after an initial week of aid, a proxy for hiring, increased 56,000 to a seasonally adjusted 1.903 million during the week ending March 22, the claims report showed.?

That was the highest level since the week ending November 13, 2021. The claims data have no bearing on the closely watched employment report for March due on Friday as they fall outside the survey period. Nonfarm payrolls likely increased by 135,000 jobs last month after rising by 151,000 in February, a Reuters survey predicted. The unemployment rate is forecast to be unchanged at 4.1%.

"Businesses are slowing hiring sharply amid heightened economic policy uncertainty," said Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics. "The risk ahead is that this gradual upward?trend in unemployment gathers momentum."

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama, Andrea Ricci and Paul Simao)