Weekly global economic update

Week of May 26, 2025

• US tariffs and budget choices and their impact on financial markets
• Economic conditions in the United States and Europe

US tariffs and budget choices and their impact on financial markets

• When the United States and China reached an agreement to reduce the new tariffs that had been imposed after April 9, 2025, investors breathed a sigh of relief. Yet the reality is that US tariffs remain historically high, with the average effective tariff standing at around 18%—the highest since 1934—while tariff rates among the rest of the world’s countries remain historically low. Trade liberalization in the 80 years since World War II contributed substantially to global economic growth. Since 1950, the volume of world trade has increased 4,500%. In the past 30 years, the volume of world trade has increased at an average annual rate of 4%. This has played a role in boosting global growth, reducing prices, improving living standards, enhancing efficiency and productivity, and creating jobs.

What will happen to the global trading system if the United States withdraws? It is likely that the rest of the world will seek opportunities to expand trade among one another, looking for markets to replace the United States, which has been seen as the consumer of last resort. Yet, so long as the United States continues to be a low-saving country, especially due to a large fiscal budget deficit, it will need to import capital, which means it will retain a trade deficit. And with greater obstacles to importing goods, consumer and business purchasing power will likely decline, leading to slower economic growth.

A slow-growing economy might generate less inbound investment, thereby eventually leading to a smaller trade deficit. Yet an absence of foreign capital could lead to higher borrowing costs, unless the United States reduces its budget deficit. Meanwhile, if the country becomes a less important participant in the global economy, the role of the US dollar in global trade could become diminished. This, in turn, might also contribute to higher borrowing costs in the United States. These factors could put enormous pressure on the US government to reduce its budget deficit. In the last few years, clients have often asked me when big US budget deficits would start to bite. I couldn’t answer that question. But perhaps now is the time.

Still, recent actions in the US Congress suggest an acceleration in government debt. The House passed a bill that is expected to boost the 10-year budget deficit. Under existing law, the ratio of publicly traded government debt to GDP was set to rise from 100% today to 117% in 10 years. Under the bill just passed by the House, that ratio rises to 125%, according to one independent estimate. Annual deficits would average 6.9% of GDP. This evidently alarmed investors, with one of the bond-rating agencies removing the US government’s AAA rating.

Recall that the first time a ratings agency reduced the US government’s rating was in 2011, when a conflict between the Obama administration and a Republican Congress almost led to default. Yet the rating was cut that year, and bond yields fell. That is because, as was often the case when investors perceived risk, they turn to the safety of US Treasury securities. This time is different. We have already seen investors turning away from the US dollar following the imposition of severe US tariffs. Following the Moody’s decision, US equity prices fell, bond yields rose, and the value of the US dollar fell—all indicating yet another flight from the dollar.

Even though the United States and China reached a deal, US tariffs remain very high, thereby likely leading to higher prices paid by consumers and businesses. Still, for a while, it appeared that the worst was behind us. Yet, in the past two weeks, the US administration has indicated that a new set of tariffs will be announced in the next few weeks. After all, the April 9 decision to halt very high tariffs was meant to last only 90 days, while negotiations take place. Plus, the US-China deal was also only meant to last 90 days. And, President Trump said that, while there are “150 countries” that want to reach a deal with the United States, “it’s not possible to meet the number of people that want to see us.” Perhaps this means that, in the absence of new deals, there will be higher tariffs. We simply don’t know.

Not knowing means there continues to be a high degree of uncertainty about tariffs. And uncertainty can have a negative effect on the ability of businesses to make strategic decisions. The US administration exacerbated that uncertainty when it said that many countries would soon receive letters saying that “they will be paying to do business in the United States.” That suggests higher tariffs. Yet, again, we don’t know for sure. What we do know is that, in addition to the reciprocal tariffs on many countries, the United States has launched investigations into trade in semiconductors, pharmaceuticals, copper, lumber, critical minerals, and aerospace parts. These investigations usually lead to the imposition of tariffs or other trade restrictions.

The uncertainty about tariffs continues to disrupt consumer sentiment in the United States. The University of Michigan’s index of consumer sentiment fell to its second lowest level ever in May. The index is down 32.4% from a year earlier. Notably, there was a sizable drop in sentiment for consumers self-identifying as republicans. Interestingly, 75% of survey respondents spontaneously mentioned tariffs as a reason for their pessimism—up from 60% in the previous month. Also, the average rate of inflation expected in the coming 12 months increased from 6.5% in the April survey to 7.3% in the May survey. Keep in mind that the consumer price index was up only 2.3% in April. Thus, consumers evidently expect a significant rebound in inflation. Interestingly, The Budget Lab at Yale expects inflation of 4% percent this year, almost half of which will be due to tariffs.

Finally, the tariffs that are now in effect have led to a sizable increase in customs revenue for the US government. This is effectively one of the biggest tax increases in US history. Yet, unlike a broad-based consumption tax (which the US lacks), tariffs have a distorting impact on consumption patterns. And yet, similar to any other tax, an increase in tariffs has a negative impact on economic activity. This could potentially be offset by the fiscal stimulus that the US Congress is expected to pass.

On the other hand, this could be the moment when a rising budget deficit may have a negative impact on economic activity. In recent decades, US budget deficits did not lead to higher borrowing costs, thereby enabling the deficits to have a positive impact on economic activity. The country has benefited from the strength and dominance of the US dollar. Not all countries enjoy this privilege. For example, for years, Brazil has been under pressure from bond investors to cut borrowing lest high borrowing leads to higher borrowing costs. Consequently, Brazil could probably boost economic activity by reducing its deficit. The United States could be moving in a similar direction.

Meanwhile, US bond yields continued to rise recently after the US Treasury faced a difficult sale of bonds. This comes as many investors worry about the potential impact of the legislation winding its way through the US Congress. The bill that is being considered will, according to most independent estimates, boost the volume of US government debt in the next several years. It involves sizable tax cuts, only partly offset by measures to cut spending on programs for low-income households such as Medicaid and food assistance.

From the perspective of investors, the problem is not simply that the bill involves a fiscal stimulus. Clearly, there are times when a stimulus is warranted. Yet this is not such a time. The US economy has been growing strongly, unemployment is low, inflation has receded although it is not completely defeated, and the underlying fiscal stance of the government is excessively easy. It is at such a time when a fiscal contraction makes sense. That is, it is best to attempt to reduce long-term debt at a time when the economy is healthy. The failure to offer the pretense of fiscal consolidation is what likely worries investors.

Economic conditions in the United States and Europe

• The latest composite flash purchasing managers’ indices (PMIs) for the eurozone and the United States indicated weakness in Europe but surprising strength in the United States. Still, US numbers indicate a surge in prices that was largely linked to tariffs. PMIs are forward-looking indicators meant to signal the direction of activity in an economy. PMIs are based on subindices such as output, new orders, export orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth.

Let’s begin with the United States. The composite PMI increased from 50.6 in April to 52.1 in May. PMIs for both services and manufacturing increased. The April numbers had been subdued, in part, because of fears about the potential impact of very high tariffs. In May, the temporary deal to lower tariffs with China likely had a positive impact on sentiment. Also, it should be noted that, although the PMIs rebounded in May, they remained well below levels seen in 2024. One reason for the May rebound was a surge in purchases of inputs, which were mostly put into inventory. The rise in purchases was the largest in the history of the survey. Evidently, businesses were stocking up on intermediate goods in anticipation of tariffs or shortages.

PMIs for the United States indicate a rebound in new orders, but a sharp decline in export orders. Notably, exports of services fell at the sharpest pace since early in the pandemic. A large part of service exports are foreign visits to the United States, which are down sharply.

The survey found that, in the United States, prices charged for goods and services were up at the fastest pace seen in three years. S&P Global, which publishes PMI surveys, said that “the latest rise in output prices was overwhelmingly linked to tariffs, having directly driven up the cost of imported inputs or caused suppliers to pass through tariff-related cost increases. Manufacturing input costs rose at the sharpest rate since August 2022, while service sector costs rose at the fastest rate since June 2023.” S&P also said that “supply chain delays are now more prevalent than at any time since the pandemic.”

In the eurozone, the composite PMI fell to 49.5, a six-month low, indicating declining activity. This included a sharp decline in the services PMI to a 16-month low but a modest increase in the manufacturing PMI to a 33-month high. S&P Global commented that “the eurozone economy just cannot seem to find its footing. Since January, the overall PMI has shown only the slightest hint of growth and, in May, the private sector actually slipped into contraction. Do not blame US tariffs for this one. In fact, efforts to get ahead of those tariffs might partly explain why manufacturing has held up a bit better lately.”

On the other hand, S&P also pointed to reasons for optimism about Europe. Specifically, it said that “there are reasons for confidence in the longer term. The recovery in manufacturing is broad-based, with encouraging signs coming out of both Germany and France. Further interest rate cuts could provide a boost, and lower oil prices compared to last year are also helping. Germany, in particular, might be gearing up to reclaim its role as the eurozone’s economic engine, thanks to a potentially very expansionary fiscal policy.” The latter involves Germany’s intention to borrow heavily to fund increases in spending on defense and infrastructure.

Week of May 12, 2025

• The relationship between the US trade deficit and budget deficit
• Federal Reserve pauses
• How is China coping with the trade war?
• The United States and United Kingdom reach a deal
• Global manufacturing activity eases

The relationship between the US trade deficit and budget deficit

• If, as seems possible, the US Congress passes a tax bill that boosts the budget deficit, this will likely have the effect of boosting the US trade deficit. Let me explain: In the external accounts of the US economy, there is a current account deficit (which is mostly the deficit in trade of goods and services), reflecting the fact that the United States imports more than it exports. This is almost completely offset by a capital account surplus, in which the United States experiences a net inflow of capital. These two flows go together in an arithmetic identity. That inflow of capital offsets the gap between saving and investment in the United States. Part of that inflow goes into US Treasury securities, effectively making foreigners participate in funding the US budget deficit. If the Congress passes bills that boost the budget deficit, and in the absence of an increase in domestic saving, the increase in the budget deficit would be funded by more borrowing from foreigners. And as this happens, the trade deficit will automatically widen to fund that gap.

This is not a new insight. Economists have known this for generations. One can reasonably make the argument that there is nothing wrong with a trade deficit, especially for a mature and dominant economy like the United States. Still, persistent large trade deficits lead to increases in the net external indebtedness of the United States. If that debt is used to fund profitable domestic investment, which is partly the case, then it is not a bad thing. If, however, it is used to fund government consumption, one can argue that it will likely have a negative impact on US living standards in the very long run.

Consequently, there is an argument for reducing the trade deficit. But it is not an argument for tariffs, which are unlikely to significantly reduce the trade deficit. Rather, it is an argument for reducing the government’s budget deficit. That is, if the Congress raises taxes and/or cuts spending, thereby reducing government borrowing, the gap between saving and investment declines, leading to a smaller trade deficit. This means a slower rise in the net indebtedness of the United States. Thus, if the goal is to rebalance the external accounts of the United States, the focus should be on domestic savings rather than external trade rules.

Federal Reserve pauses

• Recently, the US Federal Reserve left the benchmark interest rate unchanged. Unusually, the Fed is facing the possibility of both higher inflation and weaker economic performance, creating a conundrum in terms of policy. Fed Chair Powell said that “the risks of higher unemployment and higher inflation appear to have risen, and we believe that the current stance of monetary policy leaves us well positioned to respond in a timely way to potential economic developments.” He noted that, in the first quarter, underlying economic growth remained strong. Yet he noted that surveys of households and businesses indicate a sharp drop in sentiment, potentially auguring weakness in spending.

On trade, Powell said that the tariffs have been much larger than anticipated. Yet the policy continues to evolve and the potential economic impact, consequently, remains uncertain. He said that “if the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer-term inflation expectations well anchored.”

While investors were not surprised by the Fed’s inaction, there is now a strong expectation, as evidenced by futures markets, that the Fed will engage in multiple interest-rate reductions in the second half of the year. That expectation reflects a view that the economy will likely weaken and that the Fed will view any sudden increase in inflation as a temporary effect of tariffs.  

How is China coping with the trade war?

• After the US imposed high tariffs, China implemented severe retaliatory tariffs on the United States. In addition, it restricted exports of rare earth minerals, halted purchases of US-made airplanes, and stopped purchasing liquid natural gas (LNG) from the United States. 

Still, US Treasury Secretary Bessent said that, in the present circumstances, the United States has the upper hand because it buys more from China than it sells. China, on the other hand, appears confident given that it exports to many other countries beside the United States and that the trade war offers an opportunity to improve relations with countries that are unhappy with US action. For example, China has sought to improve relations in Southeast Asia following the threat of high US tariffs on imports from that region.

Moreover, even though China’s purchases of US exports are modest, China-based revenue of US companies is massive, potentially giving China a tool with which to put pressure on the United States. China-based revenue of the companies on the S&P 500 index is roughly six times US exports of goods and services to China. At more than one trillion dollars, this revenue source is of vital importance to many large US companies. China could, theoretically, make life difficult for these companies. So far, this has not happened.

Another potential source of leverage for China is its massive holdings of US Treasury and other dollar-denominated securities. Some observers have suggested that China could do considerable damage to the US economy if it engaged in a fire sale of US bonds. Yet a Chinese sale would result in a capital loss for China. Moreover, it is not clear where China would park money after exiting the US bond market. There is no good alternative in terms of depth and liquidity. Plus, given China’s massive volume of exports, which remain mostly valued in US dollars, China cannot afford to reduce its exposure to the US dollar—and least not yet. Consequently, a rapid Chinese sale of US bonds seems unlikely. 

The United States and United Kingdom reach a deal

• The United Kingdom and the United States reached a deal on trade. However, it is not a formal deal. Rather, it is essentially a gentlemen’s agreement, not having the force of law. Plus, the deal does not so much liberalize trade as it averts more protectionism and manages trade rather than allow free market forces to prevail. Finally, the deal leaves the UK facing greater obstacles to trade with the United States than before the tariffs were imposed in early April.

The deal leaves in place the across-the-board 10% US tariff on imports from the United Kingdom. However, it lowers the US tariff on imports of British cars from 25% to 10%. At the same time, the deal limits the 10% tariff to the first 100,000 British cars sold in the United States. Last year, 120,000 British cars were sold in the United States. Hence, this is effectively a quantitative restriction.

There is a long history of such quantitative restrictions. What we know from the past is that limiting the supply of competitively priced products leads to higher prices. In the 1980s, the United States and Japan agreed on a voluntary cap on the number of cars Japan exported to the United States. The result was a significant increase in the average price of cars sold in the United States. The new US-UK deal will, at the least, cause a sizable increase in the prices of British cars sold in the United States.

The deal also provides that steel and aluminum exported from the United Kingdom to the United States will face zero tariff, down from the current 25%. In exchange, the United Kingdom will liberalize imports of US food products while leaving in place US rules on food safety. In addition, the United Kingdom will remove a tariff on imports of US-produced ethanol. The two sides also agreed to work on a future digital trade pact.

Overall, the deal leaves in place a high degree of protection but does liberalize trade in some product areas. It does not provide for a vast increase in US market access to the United Kingdom, which presumably was the goal of tariff negotiations. One reason an agreement was reached relatively quickly is that the United Kingdom does not have a trade surplus with the United States. As such, it was not facing the threat of a very high tariff. On April 2, when President Trump proposed such tariffs, it only imposed a 10% tariff on the United Kingdom—which remains in place under this deal. As such, it is not clear if this deal provides a useful template for deals between the United States and other countries.

Meanwhile, other countries might be wary of unenforceable deals. The US had free trade agreements with Mexico, Canada, South Korea, and Israel, but still chose to impose high tariffs. Plus, the World Trade Organization (WTO), which used to adjudicate trade disputes between countries and was able to impose penalties for violations of trade rules, has been neutered by US unwillingness to appoint members of a panel on dispute resolution. Thus, there is no current method to avoid dissolution of agreements.

Global manufacturing activity eases

• The latest purchasing managers’ indices (PMIs) point to subdued economic activity in many countries. The April PMIs for manufacturing indicate contraction in many countries. Let’s look at the details.

First, PMIs are forward-looking indicators meant to signal the direction of activity in the broad services and manufacturing sectors. They are based on sub-indices such as output, new orders, export orders, employment, pricing, inventories, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth. S&P Global, which publishes the PMIs, released data for global manufacturing. Here’s the data:

The global PMI for manufacturing fell from 50.3 in March to 49.8 in April, indicating a contraction in activity. The PMI for the manufacture of intermediate goods fell especially sharply. This suggests disruption of supply chains. For the overall PMI, the sub-index for output indicated growth. However, the sub-indices for new orders, employment, and inventories indicated contraction.

Of the 32 countries analyzed, 12 had manufacturing PMIs above 50, indicating growing activity. The highest PMIs were for India, Greece, Philippines, and Ireland. The remaining 20 countries all experienced contraction. The deepest contractions were in Mexico, Canada, Myanmar, and the United Kingdom.

Now let’s look at some of the world’s major economies: In the United States, the manufacturing PMI was unchanged in April at 50.2, a level signifying almost no growth. Yet the sub-index for output indicated decline while sentiment worsened to a 10-month low. Meanwhile, output prices were up at the fastest pace in two years. Input charges increased sharply as well, mainly due to tariffs. S&P Global commented that “tariffs were widely blamed for a slump in export orders and curbed spending among customers more broadly amid rising uncertainty.” In addition, it noted that “manufacturers are responding to … changing demand, supply and cost conditions by raising their selling prices and trimming headcounts to help protect their margins.”

Also, the US PMI for services fell to 50.8, a level indicating modest growth and the lowest reading since November 2023. S&P Global said that “business and consumer facing service providers alike, and especially financial services firms, are reporting markedly weaker growth prospects, citing intensifying uncertainty over the economic outlook amid recent tariff announcements and ongoing federal spending cuts.” It also said that service exports weakened considerably, likely due to the decline in inbound travel.

In neighboring Mexico, the manufacturing PMI continued to fall sharply, hitting 44.8 in April, the lowest level since February 2021, during the pandemic. This was largely due to “near-record” reduction in export orders, described as “plummeting,” caused primarily by trade uncertainty with the United States. This situation caused worsening sentiment, leading companies to reduce stocks, dismiss workers, and reduce input purchases. Also, Canada’s manufacturing PMI fell to 45.3, the lowest reading since May 2020. Output and new orders fell sharply in April. S&P said that “the uncertainty regarding the future direction and implementation of tariffs was again especially damaging, with markets characterized by hesitancy and delayed decision making.”

In Europe, the manufacturing PMI for the Eurozone continued to indicate contraction. However, the April PMI, at 49.0, was the best in 32-months. Moreover, output increased at the fastest pace in three years. Despite the improvement, S&P Global said that “industrial activity remains highly exposed to US tariff policy, but the planned sharp increase in defense spending in the EU could help stabilize the situation in the long term. This is confirmed by the survey’s optimism gauge.” Notably, output increased sharply in Germany and France.

In China, the April manufacturing PMI remained slightly above 50, indicating growth, but the pace of growth has slowed markedly. S&P commented that “the US tariff hikes took a toll on external demand, with new export orders declining at the fastest rate since July 2023, leading to just a marginal increase in total new orders in April. The impact of the tariffs on the supply side, however, was relatively limited.” In addition, they said that “business optimism weakened to one of its lowest levels on record.”

In Japan, the manufacturing PMI rose slightly but remained in negative territory. There was a steep decline in new orders and export orders. Consequently, “This prompted firms to cut back on their purchasing activity and readjust their inventories.”

Finally, in Southeast Asia, the PMI fell below 50.0 for the first time in 16 months and to the lowest level since August 2021. Output and new orders declined. The sub-index of confidence hit a 57-month low. The sharp decline in confidence “suggests that firms may be bracing for further challenges ahead.”

Week of May 05, 2025

• Examining arguments for tariffs
• Shipments of goods are declining
• US economic data

Examining arguments for tariffs

• One of the arguments offered by the US administration to justify tariffs is that tariffs will generate a great deal of revenue for the US government, thereby offsetting the impact of tax cuts on the budget deficit. The challenge is that, as tariff rates go up, a tipping point is reached where the impact of declining imports offsets the impact of a higher tariff rate, thereby leading to an actual decline in revenue. Moreover, as tariff rates rise, reducing consumer and business purchasing power, economic activity weakens. This would lead to a reduction in tax revenue.

The Peterson Institute has calculated that it wouldn’t take long for a rising tariff rate to have a negative impact on government revenue. Specifically, it estimated that, if the United States imposes an across-the-board 10% tariff on all imports, the net 10-year boost to US government revenue would be US$1.575 trillion. Yet, if the United States imposes a 20% across-the-board tariff on all imports, the net gain in revenue over 10 years would only be US$791 billion—about half the revenue from a much smaller tariff. Both scenarios reasonably assume that other countries retaliate, thereby hurting US exports and weakening overall US economic activity. This demonstrates that there is a limit to how much revenue the US government can generate. Previous talk about replacing the income tax with tariffs has been floated by administration officials but remains challenging.

This analysis has important implications. If the US government sets tariff rates too high, it will not only hurt economic activity, but will also generate less revenue than a lower tariff rate. My view, however, is that the optimal tariff rate is zero. It has the least impact on prices and economic activity, encourages the greatest degree of efficiency by companies, and leads to the strongest economic performance, thereby generating plenty of tax revenue. If the government wants more revenue, it can raise taxes rather than simply tax imports which has a distorting impact on economic activity.

• One of the goals of the US administration in boosting tariffs is to encourage more investment in US manufacturing as a substitute for imports. This presupposes that the US manufacturing industry is suffering and has been disrupted by unfair competition from imports. Yet, is this an accurate portrayal of the US manufacturing sector? Let’s look at some numbers:

The US manufacturing sector’s value-added has been rising steadily for some time. From the first quarter of 2010 to the fourth quarter of 2024, manufacturing value-added increased 25%. However, the economy grew even faster, rendering manufacturing value-added as a lower share of GDP than previously. Still, since 2020, manufacturing value-added has remained a steady share of GDP at 9.9%. Meanwhile, since 2010, manufacturing employment has risen 11.5%.

The reason manufacturing employment rose more slowly than value-added is that industry labor productivity rose strongly, driven by investment in labor-saving and labor-augmenting technologies. For example, many manufacturers have invested in robotization. The result is that the skills mix of workers required by manufacturers has shifted, with fewer high school–educated assembly-line workers and more software engineers and other highly skilled workers.

As the mix of skills required by manufacturers has shifted, the availability of workers has become more problematic. The job openings rate for the manufacturing sector (the share of available jobs that are unfilled) is now close to the highest level ever if we exclude the period since the start of the pandemic. In other words, manufacturing in the US faces a labor shortage. And, at a time when immigration is declining, this shortage could become more acute.

And that raises the question as to whether it makes sense to shift production from overseas to the United States. If manufacturers shift production to the United States, they will require skilled workers that are already in short supply. If they bring more labor-intensive tasks to the United States, then prices will have to go much higher given the relatively high wages paid to US workers. And, if American consumers must pay much higher prices for manufactured goods, they will have less money available to pay for other goods and services, thereby potentially hurting employment in other industries.

Also, decisions to shift production from one country to another are major endeavors that cost a great deal of money and often take a long time to complete. These decisions are made based on expectations of what the economic environment is likely to be in the long term. If, for example, a company believes that a high tariff will remain in place indefinitely, then shifting production to the United States would likely make economic sense. Yet, if there is uncertainty about the duration of tariffs, such decisions could be risky. What if the administration that follows the current one takes an entirely different approach to tariffs? Then a long-term investment decision might turn out to be a poor bet. This uncertainty might potentially have a dampening effect on investment.

Shipments of goods are declining

• It is reported that shipments of goods from China to the United States have already begun to fall sharply. The Port of Los Angeles, the busiest in the United States for receiving Chinese goods, says that arrivals in the week beginning May 4 will be down by about a third from a year earlier. In addition, by mid-April, the number of containers booked for shipping from China to the United States was down 45% from a year earlier. Also, the world’s largest container shipping company said that Chinese customers had cancelled 30% of their outbound shipments. Finally, it is reported that the number of containers booked to travel from Asia to the United States in May is down 25% from a year earlier.

It is likely that these trends reflect businesses taking a wait and see approach, especially as the US administration has said that the 145% tariff on imports from China will come down. It is worth recalling that statements about reducing the tariff began immediately after the CEOs of three large US retailers met with President Trump, warning that empty shelves were coming. Yet will shipments continue to be cancelled if the United States and China fail to reach an agreement? Or will shipments resume, but with goods sold at much higher prices than previously? The answer is likely a bit of both. If tariffs remain in place for a while, businesses will ship a lower volume of goods and sell them at high prices. The decline in volume will be due to lesser demand for higher-priced products.

On the other hand, the number of ships arriving at the Port of Los Angeles last week was up 56% from a year earlier. This likely reflects front-loading of shipments, mainly by exporters from Southeast Asia who are enjoying the 90-day pause in reciprocal tariffs. Inventories of goods from Southeast Asia will accumulate, or consumers will purchase them in anticipation of potentially higher tariffs. We already saw a surge in total US retail sales in March due to anticipation of tariffs.

US economic data

• The US government released the much-anticipated data on first-quarter GDP: Not surprisingly, real (inflation-adjusted) GDP fell from the previous quarter at an annualized rate of 0.3%. It was the first quarterly decline in real GDP since 2022. However, it was entirely due to a sharp increase in imports, which is subtracted from GDP. Real imports of goods increased at an annualized rate of 50.9%, largely front-loading in anticipation of tariffs. This cut 4.8 percentage points off GDP. This was partly offset by a substantial increase in business inventories, which added 2.3 percentage points to GDP. Thus, it appears that businesses imported heavily and added to their inventories.

Meanwhile, the core parts of GDP did reasonably well. Consumer spending and business investment were up at healthy rates, suggesting that, in the first quarter, underlying economic performance was good. The first quarter ended just a few days before the announcement of massive tariffs on April 2.

However, even the underlying trends were affected by expectations of tariffs. For example, nonresidential fixed investment was up at stunning rate of 9.8%. This was almost entirely due to investment in equipment rising at a rate of 22.5%. That was probably a case of businesses rapidly purchasing equipment (computers, telecoms, transport equipment) in anticipation of tariffs. On the other hand, investment in structures (factories, warehouses, office buildings) increased at a paltry rate of 0.4%. That suggests that businesses started to put longer-term investment decisions on hold. Also, investment in intellectual property (software, research and development) increased at a strong rate of 4.1%. The threat of tariffs and uncertainty about tariffs likely led globally exposed companies to postpone decisions about supply chain investment. In the coming quarters, this could show up as a weakening of overall business investment.

In addition, consumer spending increased at a modest but healthy rate of 1.8%, down from the strong growth of 4.0% in the fourth quarter of 2024. Spending on durable goods was down 3.4%, while spending on nondurables and services increased 2.7% and 2.4%, respectively. The decline in durables was entirely due to weaker spending on automobiles. Notably, the March retail sales numbers showed strong growth in spending at automotive dealers, but much of that increase might have been due to price increases rather than volume gains. The strength of nondurables was largely due to increased spending on apparel, probably in anticipation of tariffs. As such, much of the GDP report was influenced by tariff uncertainty, even though President Trump said the decline in real GDP had “nothing to do with tariffs” and attributed the decline to the former administration. In any event, this report makes it difficult to draw firm conclusions.

Going forward, we don’t know if the tariffs that were postponed for 90 days will be implemented or abandoned. We don’t know if, as the president suggested, the tariffs on China will come down substantially. And we don’t know what other trade actions might be taken by the United States or its trading partners. Thus, it is immensely hard to predict how the US economy will evolve in the coming months. Asset prices currently reflect an increased probability of a US economic downturn. US equity prices fell today, not only on news of negative GDP growth, but also news of weak earnings reports from key companies. Even without any change in the tariff regime, uncertainty prevails, which likely has a chilling effect on many business and consumer decisions. Thus, it appears likely that, at the least, US economic growth will be much slower in the coming quarters than in the past year. One caveat is that, when imports revert to normal next quarter, GDP growth could temporarily accelerate.

• Investors were initially euphoric when the US government reported better than expected, albeit moderate, employment growth in April. Given market concerns that trade wars are expected to lead to significant economic weakness, the employment report offered investors some sense of relief. However, it is important to note that employment data tends to be a lagging indicator of economic activity, rather than a leading indicator. In other words, employment numbers will likely only start to worsen after the overall economy has worsened.

In any event, the US government issues a monthly employment report that includes data from two surveys: a survey of establishments and a survey of households. The data from both surveys was better than anticipated. First, let’s look at the establishment survey: It found that 177,000 new jobs were created in April, slightly lower than the downwardly revised 185,000 created in March.

The manufacturing sector saw no growth in employment, with most of the growth coming from services. There was no growth in retailing, but there was strong growth in transportation and warehousing. There was only modest growth in financial services as well as professional and business services. Rather, there continued to be strong growth in health care and social assistance. There was modest growth in leisure and hospitality and almost no growth in government. Regarding the latter, there was modest growth for state and local governments, partly offset by a modest decline in federal government employment. Overall, job growth was extremely modest except for health care and transportation.

In addition, the establishment survey reported hourly earnings of workers on average, which were up 3.8% from a year earlier, the same as in March, which was the lowest since last July. Thus, wage pressure appears to have abated, possibly a sign that the previous tightness of the labor market is easing.

The separate survey of households, which includes data on self-employment, found that the labor force grew far more rapidly than the working-age population, thus boosting the participation rate. At the same time, employment grew almost as rapidly as the labor force, rendering the unemployment rate unchanged from March to April at 4.2%. Also notable was the fact that the number of discouraged workers fell from March to April, after having increased in the previous two months. In addition, U-6—a measure of the unemployment rate that takes account of workers marginally attached to the labor force as well as those forced to work part time—fell from 7.9% in March to 7.8% in April.

In response to today’s jobs report, US equity prices rose, hitting the level last seen just prior to the US announcement of tariffs on April 2—also known as Liberation Day. Investors were evidently pleased by the jobs report. Plus, it is reported that some investors believe the worst of the trade war is behind us. The yield on the US Treasury’s 10-year bond increased on the view that a healthier-than-expected economy boosts the likelihood of a tighter monetary policy. The US dollar fell moderately. The yen rose due to heightened expectations of a US-China trade deal, thereby reducing the impetus to see the yen as a safe haven. The euro rose on news of higher-than-expected inflation in the eurozone.

Week of April 28, 2025

• US economic performance
• The IMF downgrades its forecast for the global economy
• The unfolding US-China economic relationship

US economic performance

How is the US economy doing, given the policy changes that have taken place? We will learn how the US economy performed in the first quarter when the government releases the GDP report later this week. But there are other indicators that offer hints about the direction of activity. Here are a few:

• The Federal Reserve periodically issues the so-called “Beige Book,” which is a qualitative assessment of the US economy based on interviews with business and financial leaders around the country. The report looks at the broad US economy as well as economic activity in each of the Fed’s 12 districts around the country. The Fed has just released the latest Beige Book for April. It says that “uncertainty around international trade policy was pervasive across reports. Just five districts saw slight growth, three districts noted activity was relatively unchanged, and the remaining four districts reported slight to modest declines.”

In addition, it said that nonautomotive consumer spending fell while spending on automobiles increased sharply, “generally attributed to a rush to purchase ahead of tariff-related price increases.” The report also found that both personal and business travel was down, with a sharp drop in visits by foreigners. In sum, the report said that “the outlook in several districts worsened considerably as economic uncertainty, particularly surrounding tariffs, rose.”

Regarding labor markets, the Beige Book found that employment was either unchanged or up slightly in most districts. It found that hiring was slower for consumer-facing businesses than for business-to-business enterprises. However, “the most notable declines in head count were in government roles or roles at organizations receiving government funding.” Several districts reported “that firms were taking a wait-and-see approach to employment, pausing or slowing hiring until there is more clarity on economic conditions. In addition, there were scattered reports of firms preparing for layoffs.” The report found good labor availability, but also found some “constraints on labor supply resulting from shifting immigration policies in certain sectors and regions.”

Finally, the Beige Book found that prices were up either modestly or moderately in most districts. However, “most districts noted that firms expected elevated input cost growth resulting from tariffs. Many firms have already received notices from suppliers that costs would be increasing. Firms reported adding tariff surcharges or shortening pricing horizons to account for uncertain trade policy. Most businesses expected to pass through additional costs to customers.” On the other hand, there were reports about margin compression as demand “remained tepid.”

On balance, the latest Beige Book was focused on talk of tariffs and their impact. This is something I’ve never seen before. It demonstrates how the tariff situation is an important factor driving business decisions.

• The latest flash purchasing manager’s index (PMI) for the United States, published by S&P Global, indicates a significant weakening of business sentiment about the future. PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing and service sectors, as well as the whole economy. They are based on subindices such as output, new orders, export orders, employment, pricing, inventories, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth.

The April flash PMI for the United States found that the composite PMI (which covers all sectors) fell to its lowest level in 16 months. The subindex for sentiment about future output over the coming year fell to the lowest level since 2022. Interestingly, however, the sentiment subindex was much better for manufacturing than for services. Indeed, the overall PMI for services worsened while the PMI for manufacturing improved.

S&P Global commented that “the early flash PMI data for April point to a marked slowing of business activity growth at the start of the second quarter, accompanied by a slump in optimism about the outlook.” It added that “output rose in April at its slowest pace since December 2023, indicating that the US economy is growing at a modest annualized rate of just 1.0%.” Finally, it concluded that “manufacturing is broadly stagnating as any beneficial effect of tariffs are offset by heightened economic uncertainty, supply chain concerns, and falling exports, while the services economy is slowing amid weakened demand growth, notably in terms of exports such as travel and tourism.” The weakness of tourism may be related to more intense restrictions on foreign travelers coming to the United States.

Meanwhile, the subindices for prices accelerated in April. S&P Global reports that prices of goods and services were up at the fastest pace in 13 months, with prices of manufactured goods up at the fastest pace in 29 months. The higher prices were largely attributed to tariffs and their impact on import prices. S&P Global said that “these higher prices will inevitably feed through to higher consumer inflation, potentially limiting the scope for the Federal Reserve to reduce interest rates at a time when a slowing economy looks in need of a boost.” Indeed, the Fed faces a challenging task, given that it has highlighted the inflationary as well as stagnating impact of tariffs.

• The University of Michigan released the final April report from its survey of consumers. It found that, in April, the index of consumer sentiment in the United States was 52.2, down 8.4% since March and down 32.4% from a year earlier. It was the lowest reading since 2022 and the second lowest reading since 1981.

The sentiment index is based on two subindices, one concerning current conditions and the other concerning expected future conditions. The latter subindex on expected conditions fell to 47.3 in April, down 10.1% from March and down 37.8% from a year earlier. However, it is worth recalling that indices of consumer sentiment are not always good predictors of consumer behavior. Still, sharp movements in such indices are notable and offer insight into what might happen.

Also, expectations for inflation in the next 12 months increased from 5% in March to 6.5% in April. It was only 2.7% in October 2024, which means it has increased very rapidly. Expected 12-month inflation is now the highest since October 1981. The sharp increase is primarily due to the expectation that tariffs will lead to a big increase in prices. Interestingly, the separate breakeven rate, which measures bond investor expectations of inflation, has lately declined. This reflects increased expectations of a US recession and its impact on inflationary pressure.

The IMF downgrades its forecast for the global economy

• According to the International Monetary Fund’s recently released “World Economic Outlook” for April 2025, the US trade policy is currently undergoing a historic shift, prompting a significant change in the IMF’s outlook for the global economy. The US average tariff rate has risen sharply, echoing the dramatic increase seen following the passage of the Smoot Hawley tariff in 1930, which is widely believed to have exacerbated the Great Depression. The recent increase in the US average tariff rate has been even greater, pushing the average tariff rate to its highest level since the early 20th century.

The IMF periodically releases a forecast of economic growth and other indicators for most of the world’s countries. They convey useful guidance about the potential impact of changes in economic policies and other structural shifts in the global economy. In the latest outlook, the IMF notes that recent events have led to changes in the outlook. Specifically, the IMF said that the actions of the United States and other governments have brought “effective tariff rates to levels not seen in a century. This, on its own, is a major negative shock to growth. The unpredictability with which these measures have been unfolding also has a negative impact on economic activity and the outlook and, at the same time, makes it more difficult than usual to make assumptions that would constitute a basis for an internally consistent and timely set of projections.” The forecasts must be made based on assumptions that could quickly change.

In any event, the IMF has downwardly revised its expectations for global economic growth as well as for growth in almost every major country. It now expects that the global economy will grow 2.8% this year, down from 3.3% in its January forecast. Most notably, it revised its forecast for US economic growth from 2.7% in January to 1.8% now. For the eurozone, however, the revision was more modest, going from 1% in January to 0.8% now (with a growth forecast of 0% for Germany). There were more sizable revisions for the United Kingdom and Japan (growth downwardly revised by 0.5 percentage points), and Canada and China (downwardly revised by 0.6 percentage points). The 2025 growth forecasts are now 1.1% for the United Kingdom, 0.6% for Japan, 1.4% for Canada, and 4% for China. The latter figure is much lower than in recent years.

Regarding the United States, the IMF said that “the downward revision is a result of greater policy uncertainty, trade tensions, and a softer demand outlook, given slower-than-anticipated consumption growth.” In addition, the IMF model expects a sharp decline in US exports, mainly because it expects a sharp appreciation of the dollar against other currencies. That would be the normal pattern. However, the dollar has lately fallen sharply as global investors have increasingly sought safety in other countries. For China, the sharp downward revision of GDP growth reflects the impact of tariffs and retaliatory tariffs, both of which are expected to more than offset the positive impact of a more expansive fiscal policy.

The unfolding US-China economic relationship

• Equity prices rose after it was reported that US Treasury Secretary Bessent told a private gathering of investors that the trade situation with China will not continue. He said that the United States and China would reach an agreement in the “very near future.” He also said that the current high level of tariffs is “not sustainable” and that it merely represents a temporary “embargo.” On the other hand, he said that negotiations would be a long “slog.” He did not make clear what the United States will seek from China or what the United States is willing to give in return. Still, he said that “the goal is not to decouple.”

Meanwhile, President Trump concurred and said that tariffs “will come down substantially.” There are reports that the US administration is considering unilaterally reducing the tariffs on China. One report said that White House officials are thinking about cutting the tariff on Chinese imports to between 50% and 60% from the current 145%. It was also reported that they are considering a tiered approach to tariffs, with high tariffs on goods deemed important to national security and low tariffs on other goods.

China’s government said that the United States should “completely cancel all unilateral tariff measures” if it expects China to negotiate. A Chinese official said that “there have been no consultations or negotiations between China and the United States regarding tariffs, let alone reaching an agreement.”

In response to China, US Treasury Secretary Bessent said that there will be no unilateral moves by the United States. He said that “there would have to be a de-escalation by both sides.” Moreover, he said that “a breakdown between the two countries on trade does not suit anybody’s interest.”

Which country is in a better bargaining position? It could be China. After all, only about 15% of Chinese exports go to the United States. Yet many US companies rely heavily on intermediate products imported from China, some of which are not available anywhere else. Of particular importance are the rare earth minerals that China is withholding. China is the biggest exporter and the United States the biggest importer of rare earths. In addition, medical-device manufacturers have warned that, because of the trade war with China, there could be substantial price increases as well as shortages for critically important medical equipment. Meanwhile, it has been reported that Chinese factories are slowing production and furloughing some workers, due to the US tariffs and an expected sharp decline in exports to the United States.

Although the United States and China both maintain exceptionally high tariffs on one another’s imports, the United States has now chosen to exempt automotive parts from the 145% tariff. This is being done to help US automotive companies to maintain competitiveness. However, a 25% tariff on auto parts will remain and is due to take effect in early May. The 25% tariff on imported automobiles will also remain. It is useful to recall that, when President Trump imposed tariffs on China in 2018, the US administration ultimately allowed thousands of very specific exemptions. This may happen again.

It is reported that China is exempting aerospace parts from US tariffs. While China has stopped taking deliveries of US-made jets, it continues to aspire to build a globally competitive aerospace industry and, consequently, needs key parts. Therefore, the exemption makes sense for China and is not necessarily a sign of easing tensions. On the other hand, it signals that China does not want to allow its retaliatory tariffs to hurt its ability to develop key industries.

Meanwhile, it is also reported that China has either exempted or is considering exempting other products from US tariffs. For example, there are reports that some semiconductors have been exempted. In addition, there are reports that China is considering exempting drugs and medical devices. Yet most goods imported to China from the United States remain subject to a 125% tariff. This has been especially challenging for the agriculture and energy industries in the United States.