Weekly Global Economic Update

Week of January 26, 2026

• Global investors are diversifying away from US dollars
• US household spending continues to grow faster than income
• There is a debate about whether US inflation will accelerate in 2026
• Chinese economic data continues to indicate weakness

Global investors are diversifying away from US dollars

• The Chinese central bank’s holdings of US Treasury securities fell by about 10% in the past year, hitting their lowest level since 2008. Among foreign governments, China is now the third-largest holder of US Treasuries, behind Japan and the United Kingdom. China now holds a total of US$682.6 billion in US Treasuries. As China has sold its US Treasury holdings, it has purchased other assets, including gold—a move likely contributing to the recent surge in gold prices. Meanwhile, other countries continue to increase their holdings of US Treasuries, notably Japan, the United Kingdom, Belgium, and Canada. 

China is not alone in reducing exposure to US Treasuries. One of the world’s largest bond investors said it is diversifying away from US Treasuries amid what it views as the “unpredictable” nature of US economic policy. The chief investment officer of this company said that “it’s important to appreciate that this is an administration that’s quite unpredictable. What are we doing about that? We’re diversifying. We do think we’re in a multiyear period of some diversification away from US assets.” 

Why are both public and private investors becoming wary of US Treasuries? It has a lot to do with perceptions about the future path of the Federal Reserve. The Fed is currently expected to gradually cut short-term interest rates. Normally, this would be done in response to low inflation and weak economic growth. Under such conditions, an easing of monetary policy would likely lead to lower bond yields, reinforcing investors’ expectations of lower inflation. 

This time could be different, especially if there is a perception that Fed policy is being influenced by the US administration. If investors believe the Fed is being influenced, their expectations of inflation would probably increase. That, in turn, would lead to higher bond yields (lower bond valuations). The expectation that this could happen might lead many investors to reduce their exposure to US Treasuries. In doing so, they might even cause a rise in yields.

The concern about Fed independence stems, in part, from the recent announcement of a criminal investigation of Fed Chair Powell. Moreover, Powell’s term as chairman expires in May and it is widely expected that the person appointed to replace Powell will be favorably disposed toward rapid cuts in short-term interest rates. 

There are other factors that could be influencing the caution regarding US Treasuries. Chief among them is the current US fiscal policy, which many investors view as unsustainable. Moreover, some investors might believe that neither US political party is taking the fiscal imbalance seriously. In addition, foreign investors might worry that the value of the US dollar will continue to decline as it did in 2025. The decline was partly driven by concerns about the unpredictability of US trade policy and deteriorating US relations with its traditional allies. 

Against this backdrop, the yield on the US Treasury’s 10-year bond has risen lately. Currently, at 4.23% as of this writing, it is the highest level since the beginning of September. Since the start of December, the yield has risen about 24 basis points. This increase likely has to do with increased concerns about Fed independence and concerns regarding Greenland. On the other hand, there are other factors that could be driving up the yield including favorable economic data releases.

US household spending continues to grow faster than income

• American households are evidently keen to maintain their standard of living. In each of the last seven months, household spending increased faster than disposable personal income. The result, of course, was that the personal savings rate steadily declined, hitting 3.5% in November, which was the lowest rate since October 2022. In addition, in the past two months, roughly one-quarter of the increase in household spending was on health care (some of that spending was undertaken by insurance companies). This information comes from the latest US government report on personal income, expenditures, and the Fed’s favorite measure of inflation. Let’s look at the details.

In November, real (inflation-adjusted) disposable personal income (after taxes) rose only 0.1% from the previous month. Moreover, over the past year it has barely budged. In November, real disposable income was just 1% higher from a year earlier. Yet real household expenditures in November rose 0.3% from the previous month. Moreover, real consumer expenditures were up 2.6% from a year earlier. 

In addition, real expenditures on durable goods rose 0.6% from October to November. Spending on non-durables rose 0.5% while spending on services rose 0.2%. 

The report on income and spending included data on the Fed’s favorite measure of inflation, which is the personal consumption expenditure deflator, or PCE-deflator. This measure rose 2.8% in November versus a year earlier. This was the same as in September, which was the highest rate since April 2024. Thus, inflation has modestly accelerated in the past year and a half. 

When volatile food and energy prices are excluded, the core PCE-deflator rose 2.8% from a year earlier, roughly the same as during the past eight months. Thus, underlying inflation has evidently stalled at a rate still significantly above the Fed’s target of 2%. Moreover, the Fed has indicated an expectation that inflation will accelerate in 2026 due to the temporary impact of tariff increases. Moreover, the economy has performed better than previously expected. As such, a compelling argument could be made that the Fed needn’t cut interest rates any further unless there are signs of economic weakness. 

Meanwhile, the government also reported that, from a year earlier, prices of durable goods rose 1.2%, non-durables rose 1.6%, and prices of services rose 3.4%. Regarding durables inflation, it clearly has accelerated while inflation for services has been relatively steady. The acceleration for durables likely reflects the impact of companies passing on part of the cost of tariffs to their customers. The November reading for durables was the highest since November 2022. Excluding the duration of the pandemic, durables inflation in November was the highest since March 1995.

There is a debate about whether US inflation will accelerate in 2026

• US inflation in 2025 did not accelerate as much as expected earlier in the year. The impact of tariffs and changes in immigration policy, both of which were expected to cause a significant acceleration in inflation, was more muted than anticipated. This has led some observers to expect inflation to remain relatively steady in 2026. This view assumes that tariffs and restrictive immigration policy are not as inflationary as previously believed. In addition, some observers believe that productivity gains will suppress inflationary pressure. Plus, those observers believe that the Fed will step in quickly if inflation rears its ugly head. 

On the other hand, there is a view that inflation may surprise on the upside in 2026, potentially reaching or exceeding 4% by the end of the year. If that happens, it will likely put pressure on the Fed to either keep interest rates steady or even tighten monetary policy. Of course, if the Fed eases monetary policy even as inflation accelerates, the likely impact would be a rise in long-term borrowing costs as investors upwardly revise their expectations for future inflation.

Why do some observers believe that inflation will accelerate? There are several reasons. First, the impact of tariffs could intensify. History shows that the pass-through of tariffs takes place gradually. Plus, the choice to hold back on price increases in 2025 was due, in part, to the ability of companies to dip into the vast inventories of goods that were imported prior to the imposition of tariffs. That ability will be gone in 2026. Pass-through, therefore, becomes more likely.

Second, a study by the Peterson Institute says that immigration restrictions have led to labor shortages in key industries. Yet it found that “there's no evidence of native-born workers filling these positions, no surge in automation investment, and no meaningful wage increases in these industries, yet output has stayed up. When deportation effects fully materialize, labor shortages in migrant-dependent sectors will intensify, forcing wage increases that feed into services inflation.” 

Third, the fiscal impact of the One Big Beautiful Bill is scheduled to kick in during 2026, essentially providing a fiscal stimulus to the economy due to tax cuts and increases in some expenditures. Given labor shortages, this could certainly be inflationary. Moreover, if the Supreme Court were to eliminate the existing tariffs that are based on a national emergency, tariff revenue could decline temporarily, adding to the stimulus. 

Finally, the big unknown is what the Fed will do. There are differing views about the outlook for monetary policy and about the current state of monetary policy. Some analysts see the current position as stimulative, suggesting that the Fed should not cut rates any further. Others, especially those in the US administration, believe that current monetary policy is stifling economic recovery. How the Fed acts in the coming year could have a big impact on inflation and expectations of inflation. 

Chinese economic data continues to indicate weakness

• China’s government recently released the latest batch of economic data. It indicated relative weakness. Economic growth decelerated in the fourth quarter as did retail sales. Meanwhile, fixed asset investment declined and the decline in home prices accelerated. On the other hand, overall economic growth for all of 2025 remained stable and on target. Let’s look at the details.

In the fourth quarter of 2025, China’s real (inflation-adjusted) GDP rose 4.5% from a year earlier. This was down from 4.8% in the third quarter and was the slowest rate of annual GDP growth since the second quarter of 2022. On the other hand, real GDP rose 1.2% from the third to the fourth quarter, which was the best quarterly performance in three quarters. For all of 2025, real GDP rose 5% from a year earlier, in line with the government’s goals. Growth was largely driven by exports as consumer spending and business investment exhibited weakness. Even though exports to the United States fell sharply, exports to other countries did very well, in part due to aggressive pricing, which led to declining business profits. It also contributed to disinflationary pressure. 

Retail sales in China rose only 0.9% in December versus a year earlier. This was the slowest pace of growth since December 2022. Weakness stemmed, in part, from the end of incentives for purchases of appliances. Indeed, sales of home appliances and audio-visual equipment declined 18.7% from a year earlier. In addition, sales of automobiles declined 5%. On the other hand, sales of communications equipment rose 20.9% from a year earlier. Overall weakness was probably related to continued challenges in the property market, which have had a negative impact on household wealth. 

Industrial production in China grew at a healthy pace of 5.2% in December versus a year earlier. This included 5.7% for manufacturing. In addition, production was up strongly for automobiles (up 8.3%), computers and communications equipment (up 11.8%), and railway and shipbuilding (up 9.2%). With production rising faster than domestic consumption, exports become imperative. Yet with exporting to the United States having become more challenging, exports to other countries must grow rapidly. This requires competitive pricing. That, in turn, is already creating tensions with various trading partners.

Fixed asset investment in China fell 3.8% in 2025 versus 2024. It was the first annual decline since 1989, although there were steeper monthly declines during the pandemic. This mostly reflected a sharp 17.2% decline in investment in property. Yet even excluding property, investment performed poorly, down 0.5% from a year earlier. Indeed, investment in the manufacturing sector increased only 0.6% in 2025 versus 2024. Given possible excess capacity in many industries, it is not surprising that investment is weakening. 

The Chinese government reported that, in December, an index of prices of newly built homes in 70 major cities declined 2.7% from a year earlier, the steepest decline since July 2025. This suggests that the challenges in the residential property market are not over. That, in turn, is likely affecting household wealth and contributing to softer consumer spending. In addition, the property market troubles have rendered a notable decline in property investment. Until the residential property market stabilizes, it is likely that the overall economy could continue to face headwinds.

Finally, China continues to face significant demographic headwinds. This is despite government incentives for couples to have children and increased subsidies for childcare. The government reports that, in 2025, the number of live births declined 17% from the previous year. At 7.92 million babies, the number of births in 2025 declined by roughly 10 million from the peak seen in 2016. Also, because of the decline in births and a rise in deaths, the total Chinese population declined by 3.39 million from the previous year.

Evidently, people are choosing to have fewer children. Notably, people are avoiding or delaying marriage. In 2024, there were 6.1 million marriages, down 20% from the previous year and the lowest number since 1980. These trends ultimately lead to a decline in the ratio of workers to retirees, thereby putting stress on pension and health care costs. In addition, a declining working-age population will mean slower economic growth, absent an acceleration in labor productivity growth.

Week of January 19, 2026

• China’s massive trade surplus: Is it a good thing for China?
• Is fiscal dominance coming to the United States?
• US inflation is surprisingly tame
• The US administration addresses the affordability issue
• Germany’s economy grew in 2025 for the first time in three years

China’s massive trade surplus: Is it a good thing for China?

• Last year, China reported a substantial trade surplus. Is that a good thing for China and a bad thing for the rest of the world? Or is it the opposite? Or is it none of the above?

First, let’s look at the data:

The Chinese government reported that, in December, exports (denominated in US dollars) were up 6.6% from a year earlier. And this was despite a notable decline in exports to the United States. Thus, China managed to significantly boost exports to the rest of the world.

For all of 2025, China had a US$1.2 trillion trade surplus (excess of exports over imports)—the largest surplus ever and much bigger than the US$993 billion surplus in 2024. This came about as China’s exports were up 5.5% while imports were flat. Plus, exports to the United States fell 20%. This was offset by an 8.4% increase in exports to the European Union, a 13.4% increase to Southeast Asia, and a 25.8% increase in exports to Africa. The US share of Chinese exports fell to its lowest level since the 1990s. In fact, exports to the United States are now significantly lower than exports to Southeast Asia.

The word “surplus” implies something good, while the word “deficit” suggests something bad is happening. Yet, if a country has a perpetual trade surplus (as is the case with China), it means that it is perpetually producing more than it consumes. Rather than acquiring imported goods and services in exchange for its exports, it is acquiring foreign currency that can be invested in or loaned to the rest of the world. For other countries, such as the United States, a trade deficit means they are consuming more than they produce and are making up the difference by selling assets or borrowing money internationally.

While politicians often bemoan a trade deficit, suggesting it is hurting domestic production and, consequently, workers, another way to look at it is that a trade deficit is often a sign of economic strength, as it indicates strong demand. Often, countries with weak demand, such as Japan and Germany, have trade surpluses. In the case of China, relatively subdued domestic demand—particularly low levels of consumer spending as a share of gross domestic product—has contributed to its reliance on exports and investment-led growth. China has accumulated a vast quantity of foreign assets, while its households have seen weaker consumption than would be the case if China’s trade was in balance.

While the Chinese government has long recognized the need to boost domestic demand, it continues to take steps that boost exports. It has provided incentives for investment in, and production of, key manufactured goods. And, with insufficient domestic demand and declining ability to export to the United States (because of tariffs), Chinese companies are engaging in promotional pricing to unload excess production onto other export markets. While this has boosted the trade surplus, it has also created disinflationary pressure and contributed to a sharp decline in corporate profit margins. Meanwhile, the measures taken to boost domestic demand have been insufficient.

Notably, many observers had expected the US tariffs to cause China’s exports to decline, leading to a drop in China’s trade surplus. This did not happen. Moreover, the persistent trade surplus is mostly not the result of trade policy. Rather, it is mainly a reflection of China’s high savings rate and policies that suppress domestic demand, leading to more production than consumption. Meanwhile, other countries, sometimes, attribute their own trade deficits to China. Yet, these deficits are often due to low savings rates and policies that boost domestic demand. In any event, persistent imbalances often lead to political conflict and, ultimately, trade restrictions and/or efforts to shift currency values. For example, the European Union is considering the imposition of import restrictions on China; the United States has already imposed substantial tariffs on the country.

Is fiscal dominance coming to the United States?

• President Trump has urged the Federal Reserve to rapidly cut short-term interest rates. Why?  He has been explicit in explaining his reasoning. He has said that lower interest rates would reduce the cost of funding government debt, thereby reducing the budget deficit. The Wall Street Journal reported that, in an interview in December, Trump “said rate cuts would help the US Treasury reduce the costs of financing US$30 trillion in government debt."

This is an unusual argument about US monetary policy. The Federal Reserve is mandated by the US Congress to minimize inflation and maximize employment. The Fed also has a role in regulating member commercial banks with the goal of maintaining financial stability. Using interest-rate policy to manage government’s debt-service costs, however, is what is sometimes referred to as “monetizing government debt.” It is not uncommon in other countries, especially emerging countries, but can often lead to much higher inflation than desired.

This raises the issue of fiscal dominance, which is when governments have such large debts that they pressure their central banks to keep interest rates low, even when higher interest rates are warranted by inflationary concerns. This often happens in emerging countries with large budget deficits but rarely in advanced economies. In the United States, the only time it happened previously was during World War II, when the Fed put a cap on bond yields by purchasing large quantities of government debt. The inflationary effects were suppressed by wage and price controls. During the Korean War, the Truman administration sought a similar arrangement, but the Fed said no. The result was a Treasury-Fed Accord in 1951, which led to more than 70 years of Fed independence.

Former Fed Chair and Treasury Secretary Janet Yellen said that “fiscal dominance is dangerous because it typically results in higher and more volatile inflation or politically driven business cycles.” And yet, higher inflation is sometimes the goal as it helps to reduce the ratio of government debt to GDP. Yellen added that “fiscal dominance is also likely to raise term premia and borrowing costs as investors become concerned that the government will rely on inflation or financial repression to manage its debt.” Indeed, if keeping short-term interest rates unusually low leads to higher expectations of inflation, longer-term borrowing costs would likely rise. That could have negative consequences for interest-sensitive sectors of the economy, such as housing, thereby leading to slower economic growth and lower tax revenue than otherwise.

Meanwhile, the president has continued to call for the Fed to cut short-term interest rates rapidly. If, in the coming months, Fed Chair Powell is replaced with a chair who wants to follow the president’s lead, one of two things could happen. One possibility is that the new chair may have limited support from other members of the policy committee to cut rates rapidly. The committee is already significantly divided. If the majority of members reject the new chair’s views, the committee might wind up voting against the chair for the first time ever, which would create higher uncertainty about monetary policy in the minds of investors.

Alternatively, if the new chair is successful in getting the committee to cut rates rapidly, investors might perceive it as the Fed being politicized and acting as the administration prefers. They will, in that case, likely boost their inflation expectations, thereby leading to higher bond yields, which would, in turn, push up mortgage interest rates and corporate borrowing costs. As such, the result could be the opposite of what the administration desires.

US inflation is surprisingly tame

• Inflation in the United States is surprisingly tame, although it remains above the Federal Reserve’s target of 2%. This raises the question as to when, or if, tariffs might be fully passed onto consumers in the form of higher prices. While there has been some pass-through, it has been modest. Many companies have held off on boosting prices significantly, hoping to retain market share and offsetting the negative impact on margins by cutting costs, including hiring. Indeed, job growth has been very modest in the past year.

However, there is a view among some analysts that the limited pass-through of tariff costs cannot continue indefinitely. If companies ultimately adjust prices, the US inflation rate could increase by 1 to 1.5 percentage points in the coming year. For now, however, inflation appears tame. Let’s look at the data:

The government did not produce an inflation report in October, while November numbers were affected by the government shutdown. However, last week, the government reported data for December. Inflation evidently was unchanged from November. There remains uncertainty as to the degree to which the shutdown continues to influence the data. The government reported that, in December, the consumer price index was up 2.7% from a year earlier—the same as in November and the lowest since July. Prices were up 0.3% from the previous month. When volatile food and energy prices are excluded, core prices were up 2.6% from a year earlier—the same as in November and the lowest since March 2021. 

Among major categories, food prices were up 3.1% from a year earlier, energy was up 2.3%, electricity was up 6.7%, pipeline natural gas was up 10.8%, shelter was up 3.2%, medical care was up 3.5%, and new cars were up only 0.3%. Durable goods prices were up 1.2%, nondurable goods were up 1.9%, and services were up 3.3%.

What does this report imply for monetary policy? Following the inflation report, the futures market–implied probability of the benchmark interest rate remaining steady this month increased compared with the day before the data release. On the other hand, the five-year breakeven rate, which measures bond investor expectations of average inflation over the next five years, has risen in the past two weeks, possibly due to concerns about Fed independence. For now, investors appear confident that the current Fed leadership will be cautious about interest rates. However, much could depend on the composition of the Fed’s policy committee later this year.

The US administration addresses the affordability issue

• One of the biggest political issues in the United States at this moment is affordability. That is, voters continue to signal that the cost of living is too high, thereby limiting the ability of voters to own homes or make discretionary purchases. President Trump has recently taken several steps meant to address the issue. These actions include the following:

President Trump announced that he is ordering Fannie Mae and Freddie Mac to purchase US$200 billion in mortgage-backed securities. The idea is to reduce the supply of mortgage-related securities, thereby putting downward pressure on mortgage borrowing costs. Yet, Fannie Mae and Freddie Mac exist, in part, to bundle mortgages and issue securities. The idea is to boost liquidity in the market and thereby increase the ability of households to obtain mortgages. Some observers note that removing securities from the market could undermine liquidity and reduce mortgage availability.

Also, on the housing front, the president said he will seek to ban institutional investors from purchasing single-family homes. This includes private equity companies that have been active in the residential property market. The idea is that investor demand for homes is driving up prices. However, institutional investors own only about 1% to 2% of single-family homes. Moreover, industry demand weakened following a steep rise in borrowing costs in the last few years. Institutional investors have mostly recently been net sellers of houses.  Industry experts say that the main problem is a lack of supply relative to demand. The solution will be to build more homes, possibly by removing regulatory obstacles to construction. Many of the obstacles, however, are at the state and local levels.

President Trump announced that he wants a two-year 10% cap on credit card interest rates.  The challenge with doing this (and this would require an act of Congress) is that an interest-rate cap would force banks to limit the availability of credit cards to those with high incomes and good credit scores. Thus, availability of credit would probably decline. In response to the president’s proposal, shares in companies that issue credit cards fell sharply.

The President is keen to lower energy costs by boosting the supply of oil and gas. That is probably why he wants US energy companies to invest in Venezuela. Yet, the reality is that the world is well supplied in oil, which is why oil prices are down sharply from a year ago.  Moreover, oil companies will only invest in new sources if the price is high enough to generate a profit. When the US administration recently held an auction for leases of land in Colorado, under which there is oil, there were no bids. The price of oil is simply too low.  Thus, it seems unlikely that the administration will be successful in driving up oil production.

Germany’s economy grew in 2025 for the first time in three years

• The German economy has traditionally been Europe’s growth engine. Unfortunately, Germany’s economy contracted in both 2022 and 2023. Now, it is reported that, in 2025, the economy finally grew—but just barely. Real GDP was up 0.2% from the previous year. Germany has long been a manufacturing powerhouse and is a big exporter of manufactured goods. Yet, exports declined sharply in 2025, while imports grew strongly. Automobile exports performed especially poorly, likely due, in part, to US tariffs as well as competition from Chinese electric vehicles.

The modest rebound in growth in 2025 was likely due to a shift in fiscal policy. Although the current government had initially focused on fiscal probity, it shifted gears in early 2025, when it became concerned about US support for NATO allies and Ukraine. Along with other NATO governments, Germany consequently chose to allow a significant increase in government borrowing to fund increased spending on infrastructure and defense. It is likely that the 2025 rebound reflected the initial phases of this spending. Moreover, as spending heats up in 2026, it should boost economic growth even more.

Going forward, fiscal stimulus and an easy monetary policy are expected to be positive factors for German growth. On the other hand, troubled and uncertain trade relations with the United States will likely be a negative factor. Also, increasing competition from Chinese producers of automobiles and capital goods could hurt Germany. One of the bigger issues facing German industries is the price of energy. The good news is that energy prices will likely face downward pressures given weak global demand and strong supply increases. If German growth accelerates in 2026, it will probably have a positive spillover effect on other European economies.

Week of January 12, 2026

• US productivity surges because of the tech industry
• The US job market shows signs of cooling even as the economy has grown rapidly
• Southeast Asia’s economy has performed well despite headwinds
• The US dollar has weakened considerably in the past year
• Inflation in the Eurozone remains subdued

US productivity surges because of the tech industry

• The US economy appears to be generating significant gains in labor productivity. Yet most of those gains appear to be heavily concentrated in the tech industry, while the rest of the economy has not kept pace. As such, the economy appears to be bifurcating. For a while, some observers have talked about a K-shaped economy in which high-income households do well while others do not. This is real. Yet there now appears to be another K-shaped aspect to the economy, involving the divide between tech and non-tech. Let me explain.

In both the second and third quarters of 2025, labor productivity grew rapidly. Does this mean that the long-hoped-for productivity gains from AI have arrived? Probably not. Rather, productivity gains are mainly increasing in the technology sector while non-tech sectors see only limited gains (figure 1). This likely reflects big increases in tech output combined with only limited gains in employment. When data centers open and start spitting out insights (or hallucinations), this is an increase in output. Yet data centers employ very few people. Hence, productivity rises very rapidly.

Yet with productivity gains being so concentrated, most of the US economy is yet to experience the beneficial aspects of these gains. Normally, widespread gains in productivity would lead to significant wage gains and, consequently, improvements in living standards. For the US economy, this can only happen when productivity gains shift from the tech industry toward most other industries. And that will happen when AI adoption in other industries generates productivity gains. The evidence suggests this transition is not yet happening and may take some time.