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

The U.S. trade deficit narrowed in June on a sharp drop in consumer goods imports, and the trade gap with China shrank to its lowest in more than 21 years, the latest evidence of the imprint on global commerce President Donald Trump is making with sweeping tariffs on imported goods. Trump's tariffs are leaving their mark on the U.S. economy beyond trade, as a measure of activity in the vast services sector hit stall-speed in July, with businesses saying the swarm of new import taxes is driving up costs and making business planning more difficult. The overall trade gap narrowed 16.0% in June to $60.2 billion, the Commerce Department's Bureau of Economic Analysis said on Tuesday. Days after reporting that the goods trade deficit tumbled 10.8% to its lowest since September 2023, the government said the full deficit including services also was its narrowest since then. Exports of goods and services totaled $277.3 billion, down from more than $278 billion in May, while total imports were $337.5 billion, down from $350.3 billion. Imports of consumer goods and industrial supplies and materials were both the lowest since the middle of the COVID-19 pandemic, while exports of capital goods hit a record high. The diminished trade deficit contributed heavily to the rebound in U.S. gross domestic product during the second quarter, reported last week, reversing a drag in the first quarter when imports had surged as consumers and businesses front-loaded purchases to beat the imposition of Trump's tariffs. The economy in the second quarter expanded at a 3.0% annualized rate after contracting at a 0.5% rate in the first three months of the year, but the headline figure masked underlying indications that activity was weakening. Last week Trump, ahead of a self-imposed deadline of August 1, issued a barrage of notices informing scores of trading partners of higher import taxes set to be imposed on their goods exports to the U.S. With tariff rates ranging from 10% to 41% on imports to the U.S. set to kick in on August 7, the Budget Lab at Yale now estimates the average overall U.S. tariff rate has shot up to 18.3%, the highest since 1934, from between 2% and 3% before Trump returned to the White House in January. "Last week's trade announcement reduced policy uncertainty, but businesses hoping tariffs were just threats must now adjust to the reality they are here to stay," Nationwide Financial Markets Economist Oren Klachkin said in a note. "We think the negative impact of high tariff rates will outweigh any positives from lower policy uncertainty." CHINA TRADE GAP A centerpiece of Tuesday's report was the latest steep drop in the U.S. trade deficit with China, which tumbled by roughly a third to $9.5 billion in June to its narrowest since February 2004. Over five consecutive months of declines, it has narrowed by $22.2 billion - a 70% reduction. U.S. and China trade negotiators met last week in Sweden in the latest round of engagement over the trade war that has intensified since Trump's return. The U.S. currently imposes a 30% tariff on most Chinese imports, which have fueled a steep drop-off in inbound goods traffic from China. Imports from China dropped to $18.9 billion, the lowest since 2009. The trade negotiators have recommended that Trump extend an August 12 deadline for the current tariff rate to expire and snap back to more than 100%, where it had briefly been earlier this year after a round of tit-for-tat increases by both sides. "We're getting very close to a deal," Trump said Tuesday in an interview on CNBC. "We're getting along with China very well." The deficit with China was not the only one to narrow. Amid a continuing impasse on trade talks with Canada and hefty tariffs imposed on autos, steel and aluminum, the trade gap with the United States' northern neighbor was the smallest in nearly five years at $1.3 billion. The trade deficit with Germany also slid, coming in at $3.8 billion and the lowest in five years. But a pair of key Asian trading partners - Taiwan and Vietnam - both posted record surpluses. SERVICES SECTOR SOFTENING The tariff effects showed signs last month of spilling over into the domestic services sector, which accounts for roughly two-thirds of total U.S. economic activity. Business activity unexpectedly flatlined in July with little change in orders and a further weakening in employment even as input costs climbed by the most in nearly three years, underscoring the ongoing drag on businesses from tariff policy uncertainty. The Institute for Supply Management's nonmanufacturing purchasing managers index slipped to 50.1 last month from 50.8 in June. Economists polled by Reuters had forecast the services PMI would rise to 51.5. A PMI reading above 50 indicates growth in the services sector, which accounts for more than two-thirds of the economy. The survey's measure of services employment fell to 46.4, the lowest level since March, from 47.2 in June. It has indicated contraction in four of the last five months, and the reading followed the release last week of the Labor Department's surprisingly soft U.S. employment report. Price pressures, meanwhile, continue to mount. The survey's prices paid index rose to 69.9, the highest level since October 2022, from 67.5 in June. Inflation until now has largely remained moderate because businesses have been selling merchandise accumulated before import duties came into effect, but data last week showed prices in some categories of goods like home furnishings and recreational gear have begun rising briskly. More benign inflation from the services sector has helped keep overall inflation in check, but the ISM data brings into question whether that trend will continue or further fan concerns about the emergence of stagflation. Respondents to the ISM survey frequently mentioned tariffs as a drag. "Trade uncertainty causing client reevaluation of feasibility for projects in certain sectors, resulting in some delays or cancellations," a respondent from the construction sector said.