Weekly global economic update

Week of June 9, 2025

• A primer to help understand the US trade deficit
• US job market: Surprising strong yet indicating potential weakness
• Eurozone inflation down while the ECB cuts rates
• Japanese births hit a record low

A primer to help understand the US trade deficit

• While there is a lot of public discussion about the US trade deficit, often the discussion does not explain how the trade deficit comes about, why it could be bad or good for the economy, and how it is related to other things such as the budget deficit, the amount of private savings, and the amount of foreign investment coming into the United States. Moreover, there are proposals to change the budget deficit and to possibly tax foreign investment, either of which could influence the size of the trade deficit. Let’s begin with the basics.

Like any country, the United States engages in trade with other countries in both goods and services. It buys more goods than it sells (a merchandise trade deficit) and sells more services than it buys (a services surplus). The two together, plus a few smaller items, make up the current account balance, which is in deficit. This means that, overall, the United States buys more from other countries than it sells. This leaves foreigners with extra US dollars. The only thing they can do with dollars, other than buy US goods and services, is to invest in the United States—which is what they do.

In fact, there is more inbound investment into the United States than outbound investment from the United States. This is an investment, or capital, surplus. The capital surplus almost exactly offsets the current account deficit. This is an arithmetic requirement. Many readers are accountants, so you’re accustomed to double entry accounts. In the external accounts of the United States, there are two sides: the current account and the capital account. Unless the US government separately engages in currency transactions, the two sides must be equal. This is the balance of payments and it, well, balances.

So, is the current account deficit a bad thing? If it is, then the capital account surplus must also be a bad thing. But can that be right? After all, a net inflow of capital into the United States adds to investment, lowers US borrowing costs, and contributes to economic growth. Those are good things, implying that the current account deficit is not necessarily bad. The angst over the trade deficit possibly stems from the negative connotation of the word “deficit.” If we simply spoke of a capital account surplus, people might think it is a good thing.

Yet surely there must be times when a current account deficit is a bad thing. When is that the case? If it leads a country to accumulate too many obligations to other countries. Some emerging countries have excessive external debts that they struggle to service. In that case, it would make sense to try to cut the current account deficit, possibly by depreciating the currency to drive more exports and limit imports. This, however, is not the situation in which the United States finds itself.

Still, the US government has a large budget deficit, which must be financed by borrowing, and much of the borrowing involves foreigners purchasing US government bonds. Thus, some of the inbound investment goes toward funding the budget deficit. Foreigners purchase bonds because they offer a favorable return. If the US government increases its deficit, it must borrow more, either from domestic savers or foreigners. If it borrows more from foreigners, this necessarily requires an increase in the current account deficit. If foreigners become wary of holding US government bonds, then they will likely push up bond yields and push down the value of the dollar, which is what has happened lately. Trade uncertainty, combined with concern that the United States is boosting its deficit at a time of full employment, has led to increased concern on the part of many investors.

Moreover, the budget bill recently passed by the US House of Representatives contains a measure (section 899) that allows the Treasury to boost taxes on foreign investors if their home country engages in discriminatory behavior toward the United States. This has generated concern on Wall Street. Taxing foreign investment, or even the threat of doing so, could reduce the volume of inbound investment and/or lead to higher borrowing costs.

However, the proposed tax on foreign investment is consistent with the argument made by Stephen Miran, Trumps’ top economist, that there is a need to curtail inbound investment. His argument is that inflows of capital, driven in part by the dominant role of the US dollar, boost the value of the dollar, thereby hurting US export competitiveness and undermining the US manufacturing sector. Miran says that this is why the United States has a trade deficit. Curtailing such investment is, therefore, meant to restore manufacturing and reduce the trade deficit. Yet this assumes that the dominant role of the dollar is hurting the United States. Instead, one can argue that the dominant role helps to keep US borrowing costs low and attracts investment, which helps economic growth.

US job market: Surprising strong yet indicating potential weakness

• The US government released its monthly employment report recently. There are two parts to the report: one based on a survey of households; the other based on a survey of establishments. The two surveys offered very different implications for the job market. The establishment survey found fairly good job growth, although most of it was in health care and restaurants. The household survey found a sharp decline in labor force participation, suggesting that the labor market is weakening. Let’s look at the details.

The establishment survey found that 139,000 jobs were created in May. While slower than in April, it was better than in the first three months of the year. Moreover, it was more job growth than is needed to absorb entrants into the labor force. As such, it was surprisingly good. Indeed, press commentary about the report was mostly favorable, and US equity prices rose accordingly.

On the other hand, the survey found that the lion’s share of job growth was concentrated in a few categories, with many categories experiencing declining employment or slow growth. For example, there was a decline in employment in manufacturing, especially in durable goods. There was also a decline in employment in retail trade and a sharp decline for professional and business services. And there was a sharp decline in employment at the Federal government. There was only very modest growth for information, financial services, transportation/warehousing, hotels, and zero growth at state governments.

Strong growth of employment was seen in health care (up 62,200), food service and drinking places (up 30,200), and local government (up 21,000). These three categories accounted for 82% of job growth in May. Thus, most categories were weak, suggesting that the labor market may be on a decelerating path.

The establishment survey also includes data on wages. It found that, in May, average hourly earnings of workers were up 3.9% from a year earlier, the same rate of growth as in the previous four months. Given that consumer price inflation in May was 2.3%, this implies that real (inflation-adjusted) wages continue to rise, thereby boosting household spending power. Still, recent surveys found that consumers expect a surge in inflation in the coming months owing to tariffs. That would imply a decline in purchasing power.

The separate survey of households was grim. It found that the number of people participating in the labor force fell 625,000 from the previous month. Thus, the labor force participation rate fell from 62.6% in April to 62.4% in May. It fell for both men and women. In addition, the survey found that the number of people not in the labor force increased 813,000 from the previous month. The number of people reporting being employed fell 696,000 from the previous month. The unemployment rate remained steady at 4.2%.

Although the two separate surveys offered very different results, the reality is that both surveys found evidence of a weakening of the job market. This could be related to the impact of tariff uncertainty. Meanwhile, President Trump pointed to the employment report as a reason for the Federal Reserve to cut the benchmark interest rate by 100 basis points. From the Fed’s perspective, the economy remains relatively strong. Moreover, there is a risk of higher inflation from tariffs.

Currently, the futures markets are pricing in a 30.1% chance of only one interest-rate reduction this year. That is up from 3.9% a month ago. In addition, markets are pricing in a 39.6% chance of two rate cuts and a 19.8% chance of three cuts this year. One month ago, investors were pricing in a 67% chance of either three or four rate cuts this year. Evidently investors have become more cautious about their expectations for the Fed, possibly because the economy has remained stronger than anticipated.

Eurozone inflation down while the ECB cuts rates

• Consumer prices in the Eurozone were up only 1.9% in May versus a year earlier. This was the lowest rate since September 2024 and the second lowest rate since April 2021. Moreover, inflation has been steadily decelerating since January of this year.

When volatile food and energy prices are excluded, core prices were up 2.3% in May versus a year earlier, the lowest rate of underlying inflation since October 2021. As such, it appears that inflation has largely been defeated in the Eurozone. This sets the stage for the European Central Bank (ECB) to continue cutting interest rates in the months to come – unless new factors create uncertainty about inflation.

Notably, prices of services were up only 3.2% in May versus a year earlier, signaling that service inflation is no longer a hot topic in Europe. Prices of non-energy industrial goods were up only 0.6% in May versus a year earlier.

By country, headline inflation in May was 2.1% in Germany, 0.6% in France, 1.9% in Italy, 1.9% in Spain, 2.8% in Belgium, and 3% in the Netherlands.

Going forward, there are several factors that could influence inflation, and consequently monetary policy, in the Eurozone. First, the value of the euro has been rising as the US dollar has weakened. This reflects growing aversion to holding dollar-denominated assets on the part of global investors. A rising euro suppresses Eurozone inflation. Second, energy prices have weakened, in part due to fears that trade wars will undermine global economic growth. This, too, suppresses inflation. Third, the lagged effect of ECB monetary policy has succeeded in anchoring expectations of inflation, thereby leading to lower inflation.

Finally, the big unknown is the outcome of trade negotiations between the United States and the EU. The former had proposed a 50% tariff on all imports from the EU. This led to an agreement to hold talks until early July. It is not known what concessions the United States is seeking from the EU in exchange for holding back on tariffs. Meanwhile, the United States has implemented steep tariffs on certain products (steel, aluminum, autos) and proposes to do so regarding other products. Thus, even if a deal is reached, these product-related tariffs will potentially invite retaliation by the EU, thus possibly boosting inflation in the Eurozone.

• As expected, the European Central Bank (ECB) cut its three main benchmark interest rates by 25 basis points. Since June 2024, the ECB has cut rates by 200 basis points, far more than the US Federal Reserve. This means that the interest rate gap between the United States and the Eurozone has widened. Normally, this would have led to a depreciation of the euro against the dollar. However, other factors, such as the increasing aversion to holding dollars on the part of global investors, have driven up the euro. The rise in the value of the euro is disinflationary as it leads to lower import prices. Thus, the ECB is in a good place, able to ease monetary policy without fear of igniting inflation.

The continuing easing of monetary policy by the ECB has been due to the sharp decline in inflation and the weakness of the Eurozone economy. The European Union reported recently that core inflation in May was only 2.3%, suggesting that inflation has finally been beaten.

Going forward, there are reasons to expect a strengthening of the Eurozone economy. First, the decline in interest rates will likely stimulate more credit market activity. Second, increased fiscal borrowing to fund defense spending could have a stimulative impact on the economy. Finally, lower energy prices, which is a result of trade uncertainty, could unleash consumer spending.

On the other hand, trade uncertainty could undermine economic growth. Negotiations are taking place between the United States and EU, the results of which will determine the impact on the Eurozone economy. If the trade uncertainty intensifies, it would likely weaken growth while possibly weakening inflationary pressure. That, in turn, could lead to more aggressive easing of monetary policy by the ECB.  

Japanese births hit a record low

• In Japan, the number of live births in 2024 fell to the lowest level since record-keeping began in 1899, down 5.7% from the previous year. This happened even though there had been an increase in marriages. Government demographers had expected this level of births, but not until 2038. Their expectation was based on the trajectory of the number of women of child-bearing age, which has been declining and will continue to decline. Yet the stunningly low number last year means that the demographic decline of Japan is happening much faster than previously expected.

The fertility rate is now 1.15 children per woman of child-bearing age. For the population to stabilize, the fertility rate would have to be 2.07 children per woman of child-bearing age. 

As a result of declining births and increasing deaths, the population of Japan, excluding migration, fell by 919,237 last year. Meanwhile, the size of the labor force has not yet begun to decline owing to increasing labor force participation by women and elderly. However, the labor force is expected to start declining in 2035. The labor force was 69.25 million in 2023 and is now expected to reach 62.87 million by 2050. A declining labor force means that, absent productivity growth, economic activity would decline. Moreover, with fewer people paying into the pension system, and the number of retirees continuing to grow, there will be further stress on government finances.

There are two potential solutions to the demographic problem. One solution is increased labor productivity, driven by the implementation of innovations through investment. Certainly, a shortage of labor, which will likely boost labor costs, will provide companies with an incentive to invest in labor-saving and labor-augmenting technologies. The other solution is immigration. The government has allowed more immigrants to come to Japan, but the numbers remain modest. Only a sizable increase in immigration would make a difference.

Week of June 2, 2025

• The ever-changing trade situation
• Growing impact of tariffs and tariff uncertainty

The ever-changing trade situation

• A lot happened recently regarding trade. First, the United States proposed a steep tariff on imports from the European Union (EU). Then the United States agreed to postpone the tariff while negotiations take place. Then a US Federal Court ruled that most of the tariffs the US administration had imposed this year were illegal. Yet an appellate court left the tariffs in place while appeals take place. Moreover, the administration has various remaining options regarding tariffs, thereby suggesting that the trade uncertainty is not over. Here are the details of what happened.

• Despite recent challenges in bond and equity markets, President Trump recently said that he will impose a 50% tariff on all imports from the EU. He said that talks with the EU were “going nowhere.” In addition, when asked what deal he seeks with the EU, he said that he is “not looking for a deal” and that “we’ve set the deal. It’s at 50%.” This suggests that the EU will face a high hurdle to dissuade the president from imposing a new and very significant tariff. On the other hand, US Treasury Secretary Bessent said that “this is in response to the EU’s pace. I would hope that this would light a fire under the EU.” His comment suggests that there could be a basis for a deal.  

However, a few days after the initial proposal, the US said that the tariffs will be postponed until July 9 while the two sides engage in talks. There are likely two possible explanations for the delay. One explanation is that the bond market reacted negatively to the announcement of an intention to impose the 50% tariff on June 1. The other is that President Trump held a productive call with EU Commission President Ursula von der Leyen. The postponement pleased bond and equity investors.

Yet many investors are making short-term bets rather than strategic bets. After all, nothing is yet certain. Meanwhile, the United States retains a 10% tariff on all imports from the EU as well as some higher tariffs on specific products. The EU remains prepared to impose punitive retaliatory tariffs on imports of specific products from the United States if a deal cannot be reached.

The importance of this issue stems from the massive volume of trade that currently takes place between the United States and the EU. In 2024, the United States imported US$606 billion in goods from the EU, more than from any individual country. The largest category of imports was pharmaceuticals, accounting for US$127 billion in imports. This is followed by automobiles at US$45 billion. Meanwhile, the United States exported US$370 billion in goods to the EU. It is the gap between these numbers that concerns the US administration, although bilateral trade imbalances are not important from an economic perspective.

As the talks proceed, it is not clear what the US seeks from the EU. The US is not seeking low tariffs as they already exist. The average EU tariff on imports from the United States is only 2.7%. Rather, the United States has signaled a desire to address non-tariff barriers, currency manipulation, and the size of the EU trade surplus with the United States. Regarding non-tariff barriers, the United States points to high value-added taxes (VATs) in Europe. Yet these are not non-tariff barriers as they apply equally to imported and domestically produced goods. Moreover, there is little chance that governments in Europe will agree to reduce their VATs as part of a trade deal. The United States has also pointed to what it claims are discriminatory regulations.

Regarding currency manipulation, it does not take place. The dollar-euro exchange rate is determined in the free market but is influenced by monetary policies of the Federal Reserve and the European Central Bank (ECB). The EU cannot commit to a specific ECB policy in its trade talks with the United States as the ECB is independent. Finally, the trade imbalance is determined in the free market. The United States might ask the EU to commit to boost imports from the United States, but the EU has no authority in this area other than to encourage member governments to boost procurement of goods from the US—perhaps defense goods. As such, it is hard to see how an agreement that satisfies US demands can be reached. On the other hand, a modest deal is not out of the question, especially if the United States wants to avoid uncertainty in financial markets.

Recall that, on April 2, the United States proposed a 20% tariff on all imports from the EU but then postponed that tariff until July 9. Then, the United States proposed a 50% tariff to start on June 1. This has now been postponed until July 9. This pattern of proposals and postponements creates a high degree of uncertainty for global companies, which must navigate the massive volume of trans-Atlantic trade and cross-border investment. It is likely that major strategic decisions are being placed on hold until there is greater clarity.

• The US Court of International Trade, a relatively obscure but evidently important panel, ruled that almost all the tariffs imposed by President Trump since his term began are illegal. Does this mean that the trade war is over? Hardly. The administration will appeal the ruling while an appellate court has allowed the tariffs to remain in place while the appeal process proceeds. Plus, even if the ruling is ultimately upheld, the administration has several options available to implement tariffs. Still, investors reacted positively, pushing up equity prices. Let’s look at the details.

The US administration had turned to the International Emergency Economic Powers Act (IEEPA) to rapidly implement significant tariffs. The IEEPA, which was passed in 1977, enables a president to quickly implement economic restrictions on other countries during a national emergency. The law does not explicitly provide for tariffs. The law was last used by President Biden to impose sanctions on Russia following its invasion of Ukraine.

In this case, the Trump Administration had determined that there is a national emergency requiring rapid action stemming from the large US trade deficit. Although the law had never previously been used to impose tariffs, the administration argued that tariffs on a wide range of countries were needed to reduce the trade deficit.

The three-judge court, ruling unanimously, said that “the Worldwide and Retaliatory Tariff Orders exceed any authority granted to the President to regulate importation by means of tariffs.” It added that “the challenged Tariff Orders will be vacated and their operation permanently enjoined.” In other words, unless this ruling is reversed by a higher court, businesses will be able to obtain refunds for the tariffs already paid. Plus, existing tariffs will go away—at least until the administration can find a different way to impose tariffs. Also, the ruling applies to the sweeping tariffs imposed on China, Mexico, Canada, and many other countries. It does not apply, however, to tariffs imposed on specific products such as aluminum, steel, and automobiles as those were based on laws other than the IEEPA.

The court explicitly rejected the argument about a national emergency, noting that the United States has had persistent trade deficits for decades without any clear damage to the economy. Indeed, the United States has had strong economic growth with trade deficits while several surplus countries, such as Japan and Germany, have had slow economic growth. Moreover, the court said that the law requires that, to utilize the law, the administration must be dealing with “an unusual and extraordinary threat.” It said that neither the trade deficit nor the inflow of fentanyl meets this standard. The administration accused the court of overstepping its authority and being “activist.”

What happens next? The administration has vowed to appeal the ruling. The next step is the US Court of Appeals in the District of Columbia. After that is the US Supreme Court, which has often deferred to presidents regarding the determination of national emergencies. On the other hand, the court might note that the constitution provides Congress with the power to impose tariffs. If the administration loses on appeal, there are several parts of the law governing trade to which it can turn to impose tariffs.

In making its ruling, the court noted that section 122 of the Trade Act enables the president to impose temporary tariffs to address “large and serious United States balance-of-payments deficits.” This power is limited to tariffs of up to 15% and only for 150 days, after which only the Congress can decide to continue the tariffs. This law might not appeal to the administration because of its limitations. Moreover, the United States does not have a balance of payments deficit, which is different from a trade deficit.

The tariffs on aluminum and steel were implemented on the basis of section 232 of the Trade Act. This gives the president the authority to protect specific industries that are under threat and are important for national security. Imposing such tariffs requires a finding that follows an investigation. Thus, it is a slow process. Still, the administration has already launched such investigations regarding pharmaceuticals, aerospace, and other industries.

Another possibility is that the administration will turn to section 338 of the Tariff Act of 1930. This law has never been used. However, it allows the president to impose tariffs of up to 50% if a foreign country is engaged in discriminatory behavior against the United States. This can include “any unreasonable charge, exaction, regulation, or limitation.” Notably, the president last week had proposed a tariff of 50% on the European Union, saying that the EU had treated the United States unfairly. 

Finally, there is also section 301 of the Trade Act. This allows the administration to impose tariffs and non-tariff barriers against countries that are deemed to have engaged in “practices that are deemed unreasonable, unjustifiable, or discriminatory and burden or restrict U.S. commerce.” However, it can be a time-consuming process that requires investigation. There are currently several 301 investigations under way. Section 301 was used by the first Trump Administration to impose a wide range of tariffs on China in 2018.

Thus, as is evident, the administration has several alternative avenues for imposing tariffs. Moreover, the administration could ask the Congress to amend the law to give the president greater discretion. This is possible but not likely. Such a change in law would require a super majority in the Senate, which will not be forthcoming.

Financial market reaction to the court ruling was largely favorable. Equity prices initially jumped on expectations that the court ruling will render fewer and lower tariffs. Investors might also be betting that other countries will take a more hardline stance in negotiations with the United States. For example, will the EU now make significant concessions if the threat of US tariffs is temporarily removed? It is not clear. Moreover, the recent pattern of threatening or imposing high tariffs, followed by postponements and reversals, would not work so well if the administration must follow the procedures embedded in laws other than the IEEPA.

Growing impact of tariffs and tariff uncertainty

• We now have early evidence of the impact of US tariffs. The US government reports that, in April, imports of goods fell at the fastest pace on record. Recall that, in the first quarter of 2025, imports had soared in anticipation of tariffs, causing a decline in real GDP. With imports falling sharply in April, and unless there is a commensurate decline in consumer and business spending, this could mean a sharp acceleration in GDP in the second quarter. On the other hand, we learned today that consumer spending on goods declined in April (see below), thus potentially hurting economic growth in the second quarter. In any event, the longer-term impact of tariffs on economic activity will not likely be discernible until at least the third quarter. Now let’s look at the details.

In April, imports of goods fell 19.8% from March, the largest monthly decline on record. This is in nominal, not inflation-adjusted, terms. By category, imports of industrial supplies were down 31.1%, imports of automotive vehicles were down 19.1%, and imports of consumer goods were down 32.3%. Meanwhile, exports were up only 3.4%. That means the trade deficit declined sharply in April, which is the administration’s goal. However, unless there is a sharp increase in national savings and/or a decline in inbound foreign investment, the longer-term trade deficit will not decline. If, on the other hand, the economy weakens, leading to a decline in savings, the trade deficit will indeed fall. But this would be at a considerable cost in terms of economic activity. Indeed, as discussed below, there was a sharp increase in personal savings in April.

• The US government reported data on personal income, personal consumption expenditures, personal savings, and inflation for April. There were significant shifts likely owing to the impact of tariffs. Let’s look at the details.

The personal savings rate increased from 4.3% in March to 4.9% in April, the highest level since May 2024. This happened because spending increased far more slowly than personal income. Specifically, real (inflation-adjusted) personal income was up 0.7% from March to April while real consumer expenditures increased only 0.1%. Notably, real spending on goods was down 0.2%, including a 0.8% decline in spending on durable goods. Real spending on non-durable goods was up 0.1% while real spending on services was up 0.3%.

Why did spending on goods decline? One likely reason is that spending had soared in March in anticipation of tariffs. Thus, consumer demand had been sated early, thereby leading to a decline in demand. Another possibility is that consumers were becoming cautious in their spending because they were increasingly worried about the economic environment, as evidenced by weak indices of consumer sentiment.

Also, the government reported data on the Federal Reserve’s preferred measure of inflation, the personal consumption expenditures deflator (PCE-deflator). The data show that, as of April, inflation was well contained. The overall PCE-deflator was up 2.1% from a year earlier, the lowest since September 2024. When volatile food and energy prices are excluded, the core PCE-deflator was up 2.5% from a year earlier, the lowest since March 2021. In other words, underlying inflation has fallen to a level last seen in the early days of the pandemic. This represents significant progress. If not for tariffs, this would be a signal that the Federal Reserve could safely continue easing monetary policy. Yet tariffs are in place and prices are likely to accelerate, thereby creating a difficult challenge for monetary policymakers.

Meanwhile, the inflation data shows that goods prices fell 0.4% in April from a year earlier, including a 0.3% decline in prices of durable goods and a 0.4% decline in prices of nondurable goods. Plus, prices of services were up 3.3%, the lowest since March 2021. For a long time, the principal concern of the Federal Reserve was persistent inflation in services. Now it appears that this is waning.