A shift in the pace of U.S. private sector expansion marked the start of 2025, with the services sector unexpectedly cooling from its December highs while manufacturing rebounded into growth territory for the first time in seven months.

However, as optimism builds among manufacturers ahead of the new administration's policies, inflationary pressures resurface, raising concerns over potential Federal Reserve action.

Services Sector Surprises With Slower Growth, Yet Weather Disruptions Weighed In

The S&P Global Flash U.S. Services PMI Business Activity Index fell to 52.8 in January, down from 56.8 in December, marking a nine-month low and falling short of analysts' expectations of 56.6, as tracked by TradingEconomics.

Some companies reported adverse weather as a factor dampening current activity, as sentiment remained relatively strong.

"Service sector confidence lost some of the shine from December's one-and-a-half-year high but remained the second-highest recorded over the past year," S&P Global wrote on Friday.

Despite the softer growth in business activity, service sector hiring surged, with job creation accelerating at the fastest pace in 30 months, a sign that firms remain optimistic about future demand.

Manufacturing Returns To Expansion

While services lost momentum, the manufacturing sector saw a long-awaited turnaround.

The Flash U.S. Manufacturing PMI climbed to 50.1 in January, up from 49.4 in December, surpassing expectations of 49.7 and hitting a seven-month high. Any reading above 50 signals expansion, making this the sector's first growth since mid-2024.

Optimism among manufacturers has strengthened, with businesses citing expectations of looser regulations, lower taxes and heightened protectionism under the Trump administration.

Many firms expressed confidence that these factors, alongside broader improvements in economic conditions, would support growth in the year ahead.

“Rising optimism is most notable in the manufacturing sector, where expectations of growth over the coming year have surged higher as factories await support from the new policies of the Trump administration, though service providers are also entering 2025 in good spirits,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.

Overall Business Activity Slows Amid Rising Inflationary Threats

The Composite PMI Index, which combines services and manufacturing data, fell from 55.4 in December to 52.4 in January, hitting a nine-month low and indicating a softening private-sector expansion.

According to S&P Global, some companies are concerned that policies like tariffs could disrupt supply chains, impact sales, or fuel inflation.

Other respondents highlighted concerns over a strong dollar, elevated costs and the risk of a more hawkish stance on interest rates than previously expected.

“Higher input cost and selling price inflation was broad-based across goods and services and, if sustained, could add to worries that a combination of robust economic growth, a strong job market, and higher inflation could encourage a more hawkish policy approach from the Fed,” Williamson added.

Market Reaction: Dollar Slumps, Stocks Pause

January's PMI data had an immediate impact on markets, with the U.S. dollar extending its weekly declines while equities and bonds remained largely flat.

The Invesco DB USD Index Bullish Fund ETF , which tracks the U.S. dollar index, dropped 0.5% on Friday, extending its weekly losses to 1.7%, on pace for its worst weekly performance since November 2023.

U.S. equities took a breather, as investors weighed rising inflation risks. By 10:05 a.m. ET Friday, the SPDR S&P 500 ETF Trust ( SPY ) was down 0.1%, while the SPDR Dow Jones Industrial Average ETF ( DIA ) eased 0.3%.

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