The Dallas Federal Reserve's business activity index climbed to 0.4 in May, pushing into positive territory for the first time in months. The reading marks a shift from contraction to modest expansion, according to the central bank's regional survey. But the improvement comes with a caveat: rising raw material costs could eat into profits down the line.
A fragile turnaround
Index readings above zero signal growth, while anything below indicates contraction. The May figure of 0.4 is a thin margin of expansion, but it still represents a clear reversal from the negative numbers reported earlier this year. The Dallas Fed does not provide a breakdown of which sectors drove the uptick, but the overall business activity component turned positive after a prolonged stretch in the red.
The shift suggests that some firms in the region are starting to see a pickup in demand or easing of earlier headwinds. Still, the index's modest level means the recovery is far from robust.
Raw material costs a looming concern
Even as the headline index improves, the Dallas Fed flagged that rising raw material costs may pressure future business profitability. The observation is based on responses from the same survey that produced the index. Companies are apparently facing higher input prices even as they try to hold onto the gains from better activity.
If those cost increases persist, firms may have to choose between absorbing the hit to margins or passing it along to customers — a move that could cool demand just as the expansion gets going. The survey did not specify which raw materials are rising, but the warning is broad enough to affect a wide range of industries.
For now, the May data offers a glimmer of optimism. But the sustainability of that growth depends on whether businesses can manage their cost side without derailing the fragile upturn. The next Dallas Fed report will show if the index can hold above zero — and whether the raw material squeeze has already started to show up in weaker profit expectations.
