KEY DATA: Deficit: $41.5 billion ($3.1 billion narrower); Exports: up $0.3 billion; Imports: down $2.9 billion
IN A NUTSHELL: “The narrowing of the trade deficits indicates growth was stronger than expected though the softening in our demand for imported products raises some questions.”
WHAT IT MEANS: The second quarter is past but we are still getting a picture of what happened. The latest number is the June trade deficit, which was a lot less than expected. On the one hand, that is good news. It looks like the negative impact that trade had in the initial GDP estimates will be revised downward, meaning that growth was likely higher than thought. However, the details are a bit strange, especially on the import side. The decline in purchases from the rest of the world was largely across the board. Demand for foreign capital and consumer goods, vehicles and industrial supplies were all off. Moderating petroleum demand, which is a trend that should continue as we replace foreign products with shale energy, played a role but is only a partial explanation. With the economy growing, consumer and business spending rising and vehicle sales robust, there is every reason to believe that imports will rebound going forward. On the export side, we sold a lot more aircraft, chemicals and medical products but not much else. Looking across the world, the Chinese economic issues have them ramping up their export machine while their purchases of U.S. products remains limited. Our trade deficits with most of the rest of the world either narrowed or turned to a surplus.
MARKETS AND FED POLICY IMPLICATIONS: The sharp narrowing in the trade deficit is something I will take every month, but I would prefer it happening by exports growing a lot faster than imports. That would be reflecting strong economic growth around the world. It is doubtful that buying less from foreigners is a trend as the U.S. economy seems to be picking up steam. So look for the deficit to widen going forward and that could mean the foreign sector will restrain growth. I still expect third quarter to show a growth rate of at least 3% as consumers and businesses keep buying and investing. With the supply managers telling us the service sector is getting on a roll, that missing link may no longer be absent without leave. If services spending, which is 45% of the entire economy, is indeed expanding more rapidly, then we should get growth between 3.5% and 4% during the second half of this year and in 2015. But the Fed seems to be in “show me” mode so a forecast of stronger growth is just that, a forecast. Until it occurs and the labor market tightens to the point where wage inflation actually shows up, this Fed seems willing to keep rates low. As for investors, we have Russia, earnings and mergers and acquisitions roiling the markets so who knows what they are thinking.