The ISM Services Prices Paid index for the United States rose to 71.3 in May from 70.7 in the prior month. The move points to firmer input cost pressures within the services sector.
May’s reading is up 0.6 points month on month, extending an already elevated level for the gauge. Markets will parse whether higher prices paid translates into stickier services inflation in the near term.
Fed Policy Expectations and Market Positioning
This latest ISM services prices number indicates that inflation within the largest part of the economy is not only high but accelerating. This data challenges any narrative that the Federal Reserve can begin to ease policy in the near term. We believe the market will be forced to price out rate cuts and potentially even price in a small chance of another hike.
Given this, we are selling short-term interest rate futures, such as those tied to SOFR, to position for a “higher for longer” rate environment. This ISM report, combined with the recent May jobs report that showed a robust 240,000 new jobs, gives the Fed little reason to pivot. We anticipate the 2-year Treasury yield, a key indicator of Fed policy, will test its recent highs in response.
Asset Allocation and Macro Market Implications
In equity derivatives, the prospect of sustained high interest rates puts pressure on company valuations. We are buying put options on the Nasdaq 100 index as a hedge against a market downturn driven by these inflation fears. We also see value in purchasing VIX call options, as we expect market volatility to rise from its current subdued levels.
The US dollar should strengthen significantly if the Federal Reserve is perceived as more hawkish than other central banks. We are adding to long positions in the dollar against the yen, where the central bank remains accommodative. The widening interest rate differential between the U.S. and other major economies makes this a compelling trade.
This dynamic feels very similar to the inflationary environment of 2022, when sticky services inflation repeatedly forced the Fed’s hand. Back then, markets that bet on an early Fed pivot were punished. We see a similar risk of complacency now and are positioning for a sharp repricing in the coming weeks.
