US trade gap skids to 2-year low; tariffs exert pressure on service sector

The U.S. trade deficit narrowed 16.0% to a two-year low of $60.2 billion in June, primarily due to a sharp drop in consumer goods imports and the trade gap with China shrinking to $9.5 billion, its lowest in over 21 years. While this tariff-driven reduction contributed to the Q2 GDP rebound, President Trump's tariffs, now averaging 18.3%, are concurrently pressuring the U.S. services sector, with the ISM non-manufacturing PMI unexpectedly flatlining at 50.1 in July, signaling rising costs, weakening employment, and potential for broader economic drag.

Analysis

The U.S. trade deficit narrowed significantly by 16.0% in June to a two-year low of $60.2 billion, a development driven by President Trump's tariff policies that suppressed consumer goods imports and shrank the trade gap with China to its lowest level in over 21 years. This reduction in the trade deficit was a key contributor to the 3.0% annualized GDP growth reported for the second quarter. However, these tariffs are simultaneously creating significant headwinds for the domestic economy. The U.S. services sector, which accounts for two-thirds of economic activity, has stalled, with the ISM non-manufacturing PMI unexpectedly falling to 50.1 in July. This reading, barely above the breakeven point of 50, was accompanied by a contraction in the employment sub-index to 46.4 and a surge in the prices paid index to 69.9, its highest since October 2022. This combination of slowing growth and rising costs, directly attributed by businesses to tariff uncertainty, signals a potential stagflationary risk and suggests the negative domestic impact of trade policy may be starting to outweigh the positive effect on the trade balance.

Key Decisions for Investors

• Given the stalling services sector activity, evidenced by the ISM PMI falling to 50.1, investors should re-evaluate exposure to domestically focused companies sensitive to rising input costs and weakening business investment.
• Closely monitor inflation data and corporate margins, as the ISM prices paid index hitting a near two-year high of 69.9 signals that tariff-driven cost pressures are intensifying, elevating the risk of a stagflationary environment.
• Adopt a cautious stance, recognizing that the positive contribution of a narrowing trade deficit to GDP may be offset by the broader economic drag from high tariffs, which have created significant policy uncertainty and are slowing business activity.