Weekly global economic update

Week of June 23, 2025

• US dollar weakness continues
• Oil prices and war
• Chinese economic data offers mixed signals
• US retail sales fall sharply while Federal Reserve sits tight
• Bank of Japan leaves policy unchanged

US dollar weakness continues

• The value of the US dollar continues to decline, with the value of the euro against the dollar recently rising to the highest level since 2021. There are many factors that can drive currency values. Often when the price of oil rises the value of the dollar declines. That is because rising oil prices reduce demand for oil. Given that oil is traded in dollars, weaker demand for oil means weaker demand for dollars. Lately, however, the price of oil fell while the dollar fell as well. Thus, the dollar’s value was evidently influenced by other factors.

One factor that drives currency values is disparity between monetary policies, or at least disparity between expectations of monetary policy. The European Central Bank (ECB) is on a path of monetary easing, with an expectation that this will continue. Meanwhile, the US Federal Reserve is taking a wait and see approach, with investors now expecting less monetary easing by the Fed than by the ECB. This set of circumstances suggests a rising US dollar. Yet that has not been the case. The futures markets meanwhile indicate that investors’ implied probability of ECB rate cuts has declined slightly due to the rise in oil prices since very recently, which might partially explain the rise in the euro. 

In any event, the continuing decline in the value of the US dollar is most likely associated with the continuing trade policy of the United States and the uncertainty surrounding this policy. The expectation that the US role in global trade will diminish potentially means less demand for dollars. Plus, uncertainty and a perception of unpredictable policy also leads investors to diversify portfolios to reduce exposure to US-related risk. These factors appear to be outweighing the impact of oil prices and monetary policies. 

While the US dollar becomes less popular with global investors, it is reported that French President Macron is urging other leaders within the European Union (EU) to take steps to make the euro a more important global currency, specifically through the issuance of joint EU debt. Indeed, IMF Managing Director Georgieva said, “There is a great opportunity for the euro to play a bigger role globally. When I look at the search for quality safe assets, at this point it is facing a constraint on the offering of these assets. It is not by chance that so much now is being parked in gold.”

Oil prices and war

• Israel and Iran are at war and the price of oil is elevated, having risen sharply when the war started. However, the price has settled at only a slightly elevated level as investors began to believe that the war is not likely to disrupt oil supplies. For the war to disrupt oil supplies, Iran would have to use force to close the Straits of Hormuz, a power that they might lack following massive Israeli attacks on Iran’s military. Moreover, even if there is disruption in the Straits, Saudi Arabia has pipelines that can bring Persian Gulf oil to the Red Sea for shipping. And, even before the war began, the Saudis had chosen to boost their production of oil, thus offsetting the impact of Israeli attacks on Iran’s oil-producing facilities. Thus, the world’s oil supply appears to be relatively safe.

Indeed, historically, conflict in the Middle East has rarely had a significant impact on the global economy. The only times in modern history that events in the Middle East were truly disruptive were in 1974 and 1979. In 1974, the war between Israel and Egypt led Arab oil producers to impose a boycott of Western countries for supporting Israel. This led to a quadrupling of the price of oil. In 1979, the Iranian revolution disrupted Iran’s oil production at a time when oil supplies were tight, thereby causing a doubling of the oil price. In both cases, global inflation soared while real income declined. Tighter monetary policies brought on recession in most major economies. Yet, when oil prices surged in 1990 following the Iraq-Kuwait conflict, the impact was short lived. The same was true in 2003 during the US-Iraq conflict and in 2022 during the start of the Russia-Ukraine conflict. This time is likely to be similar.

Chinese economic data offers mixed signals

• In China, efforts to boost the growth of consumer spending appear to be paying off while the trade conflict with the United States is undermining industrial production and investment. The government reported that, in May, retail sales (not adjusted for inflation) were up 6.4% from a year earlier, the fastest growth since December 2023. Moreover, most of that increase was real given that inflation remains close to zero. The government has provided subsidies meant to boost replacement of home appliances. In fact, retail sales of household appliances were up 53% in May versus a year earlier. Other areas of strong growth included sports and entertainment (up 28.3%), gold and silver (up 21.8%), and office supplies (up 30.5%).

On the other hand, industrial production was up more modestly, rising 5.8% in May from a year earlier, the slowest rate of growth since November 2024. The slowdown in growth was likely due to US tariffs, which reduced overseas demand for Chinese output. The manufacturing component of industrial production was up 6.2%, the slowest rate of growth since November 2024. Still, there were areas of strength. These included automotive (up 11.6%), computers and communication (up 10.2%), and railway and shipbuilding (up 10.2%).

In addition, the Chinese government reported that fixed asset investment was up a modest 3.7% in the first five months of 2025 from a year earlier. While the manufacturing component was up a strong 8.5%, investment in real estate fell 10.7%. Excluding real estate, investment increased by a more robust 7.7%.

US retail sales fall sharply while Federal Reserve sits tight

• In the United States, retail sales fell in May by the most in two years as tariffs started to have a significant impact on spending. The government reported that, in May, retail sales (not adjusted for inflation) were down 0.9% from the previous month. This included a 3.9% decline in spending at automotive dealers and a 2% decline at gasoline stations, the latter due to a decline in energy prices. When auto sales and gasoline are excluded, retail sales were down a more modest 0.1%.

Meanwhile, some other categories saw significant declines. These included home improvement retailers (down 2.7%), electronics and appliance stores (down 0.6%), department stores (down 0.4%), and food service and drinking places (down 0.9%). On the other hand, spending was up 0.9% at non-store retailers, up 1.3% at sporting goods stores, and up 1.2% at furniture stores.

Tariffs have so far not influenced consumer prices in a significant way. Thus, the decline in spending in May was likely an offset to the frontloading of spending earlier this year, which had been in anticipation of tariffs. Going forward, if prices start to rise significantly, the tariffs will likely have a negative impact on spending. 

For the Federal Reserve, this situation will represent a challenge. It will likely face higher inflation but weaker demand, the so-called “stagflation” scenario. If the Fed perceives the inflationary impact of tariffs to be transitory, it might choose to ease monetary policy. If, on the other hand, it worries that the tariff-related inflation will be self-sustaining, then it will likely keep monetary policy tight. Currently, futures markets are betting on two to three interest rate reductions later this year. 

Meanwhile, and as expected, the Fed left the benchmark interest rate unchanged. Notably, the Fed downwardly revised its forecast for economic growth and upwardly revised its forecast for inflation—both decisions based on expectations for tariff policy. The decision to leave interest rates unchanged represented the fourth consecutive meeting of Fed policymakers in which policy remained unchanged. Investor reaction was relatively muted given that the decision was expected.

The decision to hold off on interest rate moves was based on uncertainty. Fed Chair Powell said that “for the time being, we are well positioned to wait to learn more about the likely course of the economy before considering any adjustments to our policy stance.” 

Powell also said that “our job is to make sure that a one-time increase in inflation doesn’t turn into an inflation problem.” That is, although the inflationary impact of tariffs could be transitory as they are a one-off event, they could also create a wage-price spiral that would set off prolonged inflation. The degree to which this is true will depend on the tightness of the labor market. Tariffs will certainly weaken aggregate demand in the economy, thereby weakening wage pressure. On the other hand, reduced immigration could exacerbate labor market tightness, thereby boosting wage pressure. Thus, there are many moving parts that the Fed will need to consider. 

The debate about whether the one-off event of tariffs will have a transitory impact on inflation recalls a similar debate during the pandemic. At that time, Powell said that inflation was driven by supply chain disruption and would have a transitory impact on inflation. At the same time, some critics said that inflation would not be transitory and that a sizable increase in unemployment would be required to defeat inflation. It turns out that Powell was correct. Inflation went away quickly without much disruption to the labor market. The same could happen again.

Bank of Japan leaves policy unchanged

• Facing an uncertain economic environment, the Bank of Japan (BOJ) left its benchmark interest rate unchanged today. In addition, the BOJ has been reducing bond purchases as part of its effective monetary tightening. Yet the BOJ announced that it will slow down the reduction in bond purchases, evidently concerned that Japan faces significant headwinds. The BOJ currently owns more than half of Japanese government bonds, having purchased heavily when inflation was low. The recent policy of slowing purchases was meant to move Japan’s bond market toward normality. Yet the recent decision means this process will temporarily slow down.

Currently, inflation in Japan is higher than desired. Yet the uncertain trade conflict with the United States means there is a downside risk to economic growth, depending on what happens in the current trade talks with the United States. Indeed, the BOJ has downgraded its forecast for inflation as well as its forecast for economic growth. Hence, the BOJ has chosen to take a wait and see approach to monetary policy rather than continuing the path of monetary tightening meant to fight inflationary pressure. In response to the BOJ action, the yen initially rose but later stabilized.

Week of June 16, 2025

• China-US trade is disrupted
• The United States and China reach a deal
• The backdrop to the US-China deal
• What will the United States do next?
• Downward US dollar: Why is this happening?
• US inflation not yet affected by tariffs

China-US trade is disrupted

• The disruption to global trade stemming from US trade policy became apparent recently when China reported its export statistics for May. Overall exports were up a modest 4.8% in May from a year earlier. However, exports to most countries grew at a healthy pace while exports to the United States were down 34.5% from a year earlier, the steepest decline since February 2020 as the pandemic began. Recall that, during the first 13 days of May, Chinese exports to the United States faced a 145% tariff. Then, a deal between the two sides led to the US tariff falling to 30%—still high, but not catastrophic—and the Chinese tariff falling from 125% to 10%. Thus, it seems likely that the decline in exports largely took place during the first third of the month.

Meanwhile, Chinese exports the European Union were up 12% in May from a year earlier while exports were up 6.2% to Japan, 7.5% to Taiwan, 12.6% to Australia, 14.8% to Southeast Asia, and a decline of 1.2% to South Korea. The sharp rise in exports to Southeast Asia suggests that goods were being transshipped to the United States, or at least components were being sent to the region for final assembly and shipment to the United States.

Notably, Chinese exports of rare earth minerals surged in May, up 23% from just the previous month. The issue of Chinese exports of rare earths is one of the topics of discussion as US-China trade talks begin in a week or so in London. Currently, the United States imposes a minimum tariff of 30% on imports from China, with higher tariffs on some goods. China imposes a 10% tariff on the United States. The two sides agreed to postpone higher tariffs until early August while talks take place.

The United States seeks not only lower tariffs and non-tariff barriers from China, but it also wants commitments for more Chinese purchases of US goods. Perhaps most importantly, the United States wants an end to Chinese restrictions on exports of rare earth minerals, which are critically important to US technology and clean energy companies. China has signaled amenability to discussing this issue. A top US administration official said that Chinese “exports of critical minerals have been getting released at a rate that is higher than it was, but not as high as we believe we agreed to in Geneva” when the initial trade deal was reached. China accounts for roughly 60% of the mining of rare earths and 85% of the processing. Thus, it has considerable leverage. Meanwhile, China seeks lower US tariffs and fewer US export restrictions related to technology.

Also, Chinese imports fell in May from a year earlier, the fourth consecutive month in which this has happened. Imports were down 3.8% from a year earlier, which included an 18% decline in imports from the United States. That decline likely reflected the impact of China’s tariffs as well as reduced Chinese production of goods bound for the United States, which require imported inputs. China’s imports from the rest of the world were up.

Going forward, the uncertainty about the future path of trade relations between the United States and China will likely stifle any cross-border investment. Ordinarily this uncertainty would lead to increased investment outside of China as global companies seek to reduce the risk of being hurt by the fraught US-China relationship. Yet given that the United States has proposed and then postponed severe tariffs on other countries, it is not clear where companies should invest as an alternative to China. Previously Vietnam was a favored destination. Yet in early April the United States proposed a 46% tariff on imports from Vietnam, which was later postponed. US companies are now urging the US government not to impose severe tariffs on Vietnam.

The United States and China reach a deal

• The United States and China have reached a deal. The details remain spotty, but some aspects are known. In a social media post, President Trump said that the United States will have full access to Chinese rare earth minerals and magnets, and that Chinese students will be able to obtain visas for study in the United States. As for tariffs, Trump said that the United States will charge tariffs of 55% while China will charge 10%. It is not entirely clear what this entails. However, one analyst suggested that this means the United States will retain the 10% baseline tariff that has been applied to most other countries, the 20% tariff imposed early in the administration meant to compel China to address the fentanyl issue, and tariffs of up to 25% on specific products that were introduced during the first Trump Administration.

The tariffs of up to 55% are extremely high, and evidently no different than the current tariffs. Plus, this level of tariffs is likely to stifle imports or, at the least, lead to very high prices. For businesses that produce the products facing such tariffs, there will be a strong incentive to shift production elsewhere. However, not knowing what tariff rates will be applied to other countries makes it difficult to choose where to go. 

Nothing has been said about the issue of US export restrictions related to high technology products. This was an issue that concerned China. An administration official had previously said that the United States might make changes regarding this policy. Meanwhile, an Appeals court has left in place the tariffs that a lower court ruled are illegal, at least until the appeals process takes place, now scheduled to begin on July 31.   

Financial markets reacted relatively well to the announcement of the US-China deal. Equity prices were initially up but ended the day in modest negative territory. Bond yields were flat for the day.

The backdrop to the US-China deal

• During several recent presentations, I asked the audience to answer several polling questions. This was required for audience members to receive CPE credit. In each case, I asked the audience which country was likely to suffer the most from the trade wars. The choices were Canada, China, Japan, and Mexico. In every case, the audience overwhelmingly said that China would suffer the most. They were wrong.

The audiences evidently held the belief that China is hugely vulnerable to US trade restrictions. The reality is that China is far more resilient than expected and far less dependent on the United States than it used to be. Moreover, China has advantages that put the United States at risk. These facts will influence the outcome of the current trade talks between the United States and China. 

When the new US administration began, the conventional wisdom was that China’s economy was weak and vulnerable. Domestic demand was growing slowly. Export growth accounted for a disproportionate share of growth, and it faced potential obstacles from US trade policy. This meant that, if the United States puts pressure on China, it would have no choice but to make concessions. 

Yet what was forgotten was that, following the 2018 trade conflict between China and the United States, trade patterns shifted. That is because US investment into China shifted toward other places, such as Southeast Asia, with companies eager to risk their exposure to China given the fraught relationship between the United States and China. Trade patterns followed the shift in investment. From 2018 to 2024 Chinese exports grew about 42% while its exports to the United States fell about 18%. Thus, the United States was no longer of considerable importance to Chinese trade. China could afford to absorb US obstacles. Moreover, by 2024, China was already shifting economic policy toward a focus on boosting domestic demand. Thus, exports were becoming of less importance in driving economic growth.

Meanwhile, China has a trump card, so to speak. It accounts for 70% of rare earth mining and 90% of rare earth processing. In addition, it also accounts for a very large share of processing of graphite, cobalt, lithium, and copper. These minerals are critically important in the development of information technology, communications, and clean energy. Since the trade dispute of 2018, US exports to China have grown rapidly, thereby putting US exporters at risk should China impose severe tariffs. Some US companies and industries, such as agriculture and aerospace, rely heavily on China.

What will the United States do next?

• Each time there is some easing of trade tensions between the United States and other countries, some investors and pundits start to think that the trade war reached its peak and that trade tensions will decline. Yet each time this happens, something else happens to intensify the trade war. That might be about to happen. Recently, President Trump said that, within one or two weeks, he will send letters to dozens of countries outlining the terms of trade agreements, saying that they can either “take them or leave them.”

On the other hand, he also said that he is amenable to extending the July 8 deadline for determining country tariff rates, although he said he doesn’t think it will be necessary. He hinted that negotiations are taking place with 15 countries including Japan and South Korea. He added “but as you know, we have about 150-plus, and you can't [make a deal with all of them]. So, we're going to be sending letters out in about a week and a half, two weeks, to countries and telling them what the deal is.” 

Recall that, on April 2, the president proposed some very high tariffs on a wide range of countries. Then, on April 9, he paused those tariffs, pending negotiations, with a deadline of July 9. Now it appears that, with the deadline nearing, the president is simply prepared to tell other countries what he wants and what the tariff rates will be. As the president said, “At a certain point, we’re just going to send letters out.”

Meanwhile, Treasury Secretary Bessent said that, with major trading partners, there is likely to be an extension beyond July 9 if a deal is not reached soon. He said that “there are 18 important trading partners—we are working toward deals on those—and it is highly likely that those countries that are ... negotiating in good faith, we will roll the date forward."

It is hard to know how to interpret these statements, but it leaves open the possibility of high tariffs on a wide range of countries, and possibly low tariffs on others. We simply don’t know. As I’ve written before, it is uncertainty that is unnerving many business leaders, unable to make informed decisions about future supply chain strategy. 

Meanwhile, the United States has reached agreements with the United Kingdom and China. These deals did not lead to significantly lower tariffs than previously, suggesting that the United States will be content with deals that do not lower tariffs. If that is the case, then businesses should anticipate a world in which tariffs are historically high. That, in turn, would likely lead to major investments in shifting supply chain design, including some re-shoring of processes for US-based companies.

Downward US dollar: Why is this happening?

• The value of the US dollar continues to decline against most major currencies, reaching levels not seen since 2022. Normally, an increase in tariffs leads to a higher valued currency. One reason is that tariffs lead to lower volumes of imports, thereby reducing demand for foreign currency (higher demand for domestic currency). Yet in this case, we have seen downward pressure on the US dollar ever since the announcement of high tariffs in early April.

Why has the dollar’s value been suppressed? There are several reasons. First, and perhaps foremost, high tariffs and trade uncertainty have undermined global investor confidence in the global role of the United States. If US trade shrinks due to tariffs, then global demand for dollars will shrink. Consequently, global investors have been reducing their exposure to the US dollar, diversifying their portfolios and purchasing assets denominated in other currencies such as Japanese yen, Swiss francs, and euros. 

Second, the argument has been made that the strength and dominance of the US dollar has been based, in part, on the global protective role of the US military. Economist Barry Eichengreen has said that countries that are engaged in military alliances with the United States tend to hold more dollars than is warranted simply on an economic basis. This is nothing new. The same was true of the British pound in the 19th century when Britain dominated the seas. Now, with many US allies significantly boosting their own defense spending, in part due to the view that the United States is less committed to its alliances than previously, investors are shying away from dollars. Indeed, it was announced that the United States is potentially rethinking its submarine deal with the United Kingdom and Australia. 

Finally, currency values are often related to expectations of economic growth. If one country is seen as having better growth prospects than another, this tends to boost the value of the first country’s currency—all other things being equal. Lately, expectations of US growth have been downwardly revised by many economists while expectations for the Eurozone have been boosted. These trends would tend to suppress the value of the dollar.

US inflation not yet affected by tariffs

• US inflation has not yet been noticeably influenced by tariffs or lower immigration. The government reported today that inflation accelerated slightly from April to May but remains very low. Specifically, consumer prices were up 2.4% in May versus a year earlier, up from 2.3% in April. Prices were up only 0.1% from April to May.  

When volatile food and energy prices are excluded, core prices were up 2.8% in May versus a year earlier, the same as in March and April. Core prices were up 0.1% from April to May. On the other hand, core commodity prices were up 0.3% in May versus a year earlier, the biggest gain since August 2023. This might reflect the early impact of tariffs, although it is too early to say. 

Significant tariffs have only been in place since mid-April. Moreover, there had been a dramatic increase in imports during the first three months of the year, with much of that leading to a big increase in inventories. Thus, it is likely that there remains a large supply of goods that can still be sold at low prices. The impact of tariffs, consequently, will take some time to be felt. 

Meanwhile, prices of services continued to decelerate. Service prices were up 3.7% from a year earlier, the lowest since October 2021. However, service inflation in May was barely changed from April and March. Thus, it appears to be stabilizing. If the decline in immigration continues, this could lead to labor shortages in service industries, potentially boosting wage growth. The government has reported that the number of foreign-born people participating in the US labor force fell by one million from March to May, possibly due to lower immigration, but possibly due to undocumented foreigners recoiling from participation for fear of being deported.

For the Federal Reserve, the current state of inflation would ordinarily lead to a further easing of monetary policy. Yet the uncertainty about the potential inflationary impact of tariffs, as well as uncertainty about what level of tariffs will remain, will likely lead the Fed to postpone decisions about interest rates until later this year.

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.