US trade deficit hits nearly 2-year low in June; China gap plunges

The U.S. trade deficit narrowed significantly in June to a two-year low of $60.2 billion, with the gap with China shrinking to a 21-year low of $9.5 billion, reflecting the impact of tariffs. While this contributed to the Q2 GDP rebound, tariffs are concurrently exerting pressure on the domestic economy, as evidenced by the services sector hitting "stall-speed" in July (ISM PMI 50.1) and rising input costs, indicating weakening activity and mounting price pressures that raise stagflation concerns. Businesses are now adjusting to sustained high tariff rates, estimated at 18.3%, the highest since 1934.

Analysis

The U.S. trade deficit significantly narrowed by 16.0% in June to a two-year low of $60.2 billion, a development driven by a sharp decline in imports of consumer goods and industrial supplies. This trend was a primary contributor to the 3.0% annualized GDP growth reported for the second quarter, reversing a drag from Q1. A key feature is the dramatic contraction of the trade gap with China, which fell by a third to $9.5 billion, its lowest level in over 21 years, as U.S. tariffs on Chinese goods reached 30%. However, these protectionist measures are creating significant domestic headwinds. The vast U.S. services sector, representing two-thirds of the economy, nearly stalled in July, with the ISM nonmanufacturing PMI unexpectedly falling to 50.1. This slowdown is accompanied by rising inflationary pressures, evidenced by the ISM prices paid index climbing to 69.9, its highest since October 2022. The combination of weakening business activity, highlighted by a contracting employment sub-index (46.4), and accelerating costs raises concerns of potential stagflation. Businesses now face an average tariff rate estimated at 18.3%, the highest since 1934, which is creating planning uncertainty and suggests the negative impacts of sustained high tariffs may outweigh the benefits of a shrinking trade deficit.

Key Decisions for Investors

• Investors should heighten their monitoring of stagflationary risks, given the simultaneous slowdown in the services sector (ISM PMI 50.1) and a surge in its input costs (Prices Paid Index 69.9).
• Consider reducing exposure to domestic service-oriented sectors vulnerable to rising costs and slowing demand, while investigating opportunities in companies benefiting from the rerouting of supply chains away from China towards regions like Taiwan and Vietnam, which posted record surpluses.
• Maintain a defensive posture and hedge against policy volatility, as tariffs averaging 18.3% are now a structural feature of the economy, with ongoing US-China negotiations representing a key source of potential market shocks.