The RSM US Middle Market Business Index (MMBI), presented by RSM US LLP (RSM) in partnership with the U.S. Chamber of Commerce, increased to 134 in the first quarter, up 9.4 points from the previous quarter. Easing inflation and solid household consumption underscored the increase in topline sentiment that is reflective of a resilient American economic expansion in the middle market as firms continue to navigate economic headwinds and crosscurrents.

"The ability of the middle market to withstand the twin shocks of surging inflation and rising interest rates reflects an underlying resilience of households and firms to adapt to the unique challenges that characterize the post-pandemic economy," said Joe Brusuelas, chief economist with RSM US LLP. "The economy expanded at a 3 percent pace during the final six months of last year, and the robust consumer activity in January indicates that the current economic expansion is not finished."

Middle Market Sentiment Suggests Relief, though Risks Remain
The improvement in the topline index also captures the relief firms experienced as overall inflation peaked last June and continues to moderate, while the goods sector is seeing disinflation. This relief is highlighted by the 53 percent of MMBI survey respondents who indicated an increase in gross revenues in the current quarter, up from 42 percent in the final quarter of last year, and the 49 percent of participants who reported an increase in net earnings. Impressively, 57 percent of respondents stated they expect to see an increase in both gross revenues and net earnings through the middle of this year.

The combination of that resilience and relief has bolstered business confidence to the point that firms are increasing inventories in the first quarter, which poses a degree of risk going forward as the lagged impact of interest rate increases begins to sink in. More than half, or 53 percent, of respondents said they had bolstered their stock of goods, which should be monitored closely given that excess household savings are declining.

"With a 9.4-point increase in topline sentiment, middle market firms have optimism about business conditions as we start the year," said Neil Bradley, executive vice president, chief policy officer and head of strategic advocacy at the U.S. Chamber of Commerce. "Increases reported in firms' revenues and earnings for Q1 2023 and slowing inflation are driving optimism in the middle market sector. However, as household savings continue to fall, close attention will have to be paid to consumers' ability to spend throughout the year and the impact of a potential decrease in household expenditures."

Firms Experience Solid Demand and Benefit from Prices Received
Sentiment on the overall economy surged, with 47 percent of executives indicating that the economy had improved in the current quarter, up from only 28 percent previously. Forty-one percent said they expect it to improve over the next six months. RSM attributes the plurality of respondents indicating a general improvement in economic conditions to a combination of solid demand, an easing in prices paid and a mild increase in prices received.

Roughly 69 percent of respondents said that prices paid had increased, down from a recent peak of 82 percent in the third quarter of last year. Middle market firms have benefited from the correction in oil and gasoline prices and have also been aided by disinflation in the goods sector.

The survey results show that demand was so strong at the start of the year that 55 percent of respondents indicated they benefited from an increase in prices received. Approximately 62 percent of executives surveyed stated they expect to pass along higher prices over the next six months.

Additionally, middle market firms continue to prioritize capital expenditures, with 49 percent of respondents indicating they had increased outlays on productivity-enhancing software, equipment and intellectual property in the current quarter. More than half (55 percent) said they intended to do so through midyear.

Service Sector Inflation and Tight Labor Market Challenges Continue
The MMBI report cautions that service sector inflation has not yet peaked. It is up 7.6 percent on a year-ago basis through January, mostly driven by housing and housing services – both categories that are part of a complex chain of factors driving rising wages.

Employment and compensation both continue to reflect a historically tight labor market that will likely temper the robust gross revenues and earnings outlook. Of the firms surveyed, 47 percent increased hiring and 58 percent used higher compensation to attract labor in the first quarter. Looking ahead, 51 percent of respondents said they intend to hire more workers and 63 percent indicated they will increase compensation to compete for scarce labor.

The survey data that informs this index reading was gathered from 406 respondents between January 9 and January 30, 2023.