Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Ira Kalish

United States

The United States urges Europe to join in trade policy toward China

  • The recent decision by the United States to impose significant tariffs on imports of Chinese electric vehicles (EVs) comes as the European Union (EU) continues to investigate whether China is dumping EVs and other products on the European market. Within Europe, there is division on this issue. While some people call for EU tariffs on Chinese EVs, German Chancellor Scholz said that “at least 50% of the imports of EVs from China” are European brands. As such, he worries that imposing trade restrictions will hurt German companies and might impair the ability of European automobile producers to sell their products in the Chinese market. 

As this debate unfolds, the US Treasury Secretary has urged European countries to join the United States in restricting the ability of China to flood Western markets, thereby undermining the ability of Western countries to develop a clean energy manufacturing base. In a speech, the US Treasury Secretary said that the recent US action was not a “turn to protectionism” as has been suggested. Rather, she said that the tariffs are “strategic and targeted steps” meant to offset China’s policy of promoting exports of subsidized products. She said that a unified stance by the United States and EU would be impactful. She warned that “China’s industrial policy may seem remote as we sit here in this room, but if we do not respond strategically and in a united way, the viability of businesses in both our countries and around the world could be at risk.” 

Yet the EU is reluctant to quickly join the United States. European Commission President Ursula von der Leyen said that she opposes blanket tariffs. Rather, she said that “we want competition, we want to trade together, but we want it to be fair and by the rules.” Also, given that EU exports to China are a greater share of exports than US exports to China, the EU is likely worried that any restriction on trade will lead to retaliation that will hurt European companies. 

On the other hand, von der Leyen and French President Macron recently met with China’s president and made their case that Chinese state support for exports of key products is “a matter of great concern.” Von der Leyen said that “Europe will not waver from making tough decisions needed to protect its economy and security.”

Further to the discussion of the recent US tariffs, below, Michael Wolf, a global economist with Deloitte, provides answers to some questions about what the recent US tariffs might mean for business and the economy.

How much does the United States rely on China for these goods?

For some of these goods, the United States does not rely heavily on China. According to the UN Comtrade database, less than 5% of imported semiconductor devices, EVs, and iron and steel come from China. The United States is only moderately reliant on China for syringes, surgical gloves, and aluminum ore (10% to 25% import share). However, the United States is heavily reliant on China for graphite, lithium-ion batteries, and face masks (70% or more import share).

How will prices of the affected goods change?

The goods in the heavily reliant category are likely to face the strongest price pressures, though the cost burden will be diminished if US buyers can easily obtain these goods elsewhere. China only exported about a third of face masks globally, as per the UN Comtrade database, suggesting that finding new sellers may not be prohibitive. However, for graphite and lithium-ion batteries, China accounts for more than half of global exports, which will likely make finding alternative sources more difficult.

There are also reasons to expect that price changes could be somewhat limited. For example, as per the US Bureau of Labor Statistics, when 25% tariffs were placed on steel imports from all countries in March 2018, the price of imported steel jumped just 8% by July of that year. However, the price of steel then declined back to its pre-tariff price by September 2019 after tariffs on Mexican and Canadian steel were removed during USMCA negotiations in May 2019. Tariffs targeted to one country seem to have limited pass-through effects on prices.

How do companies minimize the tariff burden?

Companies could manufacture the affected products outside of China. That would allow the exporting company to avoid the cost of the tariff, but moving a factory is typically a costly endeavor. In the longer run, this may make economic sense as labor costs in China are generally higher than in places like Mexico and Vietnam. There have also been calls from the United States to place trade restrictions on goods manufactured by Chinese companies in Mexico, which may make this option risky.

Alternatively, companies could still manufacture most of their goods in China but leave part of the production process to be completed in a third country. The third country needs to create a “substantial transformation” to the product for it to be considered the new country of origin. For example, it would need to do something more than just repackaging the good. There is evidence that companies have been pursuing this option since the United States placed tariffs on China in 2018.

What are the macroeconomic effects of the tariffs?

These tariffs are likely to have a very limited effect on the US or Chinese economy. The dollar value of goods affected (US$18 billion) is very small relative to the size of economies. This suggests there will be little discernible effect on US consumer price inflation on average. Without a move in overall inflation, the central bank can maintain its monetary policy stance rather than restricting growth through higher rates. The small number of goods affected also suggests that a response from China should be limited as well. If other countries ultimately place sizable trade restrictions on China, then it could disrupt China’s new manufacturing growth engine and lead to a more pronounced weakening of the economy. That’s a possibility in the future but not a reality currently.

How might China respond to these tariffs?

Previously, China has responded by implementing tariffs on goods that will cause political pain in the United States while limiting self-inflicted harm. For example, China placed a 25% tariff on US soybeans, which has led to a substantial decline in soybean exports from the United States. China also implemented a number of non-tariff barriers at that time, such as increased inspections. One academic research paper shows that about 50% of the reduction in Chinese imports from the US in 2018 and 2019 was due to non-tariff barriers.

Will other countries also erect trade barriers with China?

Moves from non-US countries will likely be highly targeted and limited. Other countries are more exposed to trade with China, which puts them at greater risk. German automakers urged the EU to avoid placing tariffs on Chinese EVs because they are concerned that EU barriers would harm their interests in China. The EU has also taken a much more cautious approach to its trade investigations compared to the United States as it builds a case for the WTO. Japan’s manufacturers are also highly exposed to China, which would make it difficult for them to implement large barriers to trade. Even so, some countries will erect barriers. For example, Brazil recently placed tariffs on Chinese steel imports despite it being reliant on exports to China.

Japanese inflation eases, raising questions about BOJ policy

  • In mid-2023, inflation in Japan soared to the highest level in roughly 40 years. Yet the Bank of Japan (BOJ) did not respond by tightening monetary policy. BOJ leaders contended that the inflation was supply driven rather than demand driven, and that it would recede once supply disruption eased. They turned out to be partly right. Inflation in Japan has declined quickly and is now close to the BOJ’s target of 2%. 

However, compared to the inflation levels seen in the two decades before the pandemic, inflation remains relatively high. That explains why the BOJ took initial steps toward tightening monetary policy earlier this year. Moreover, the interest rate gap between Japan and the United States has fuelled a depreciation of the yen, which itself can be inflationary. Thus, the story is not over. What happens next will depend, in part, on what happens with inflation—which brings us to the latest data release.

The Japanese government reported that, in April, consumer prices were up 2.5% from a year earlier, down from 2.6% in the previous month. This was the second lowest rate of inflation since June 2022. Inflation had peaked at 4.3% in January 2023. The Japanese government has two other major measures of inflation. Core inflation excludes the impact of fresh foods and was 2.2% in April. A more important, measure, core-core inflation, which excludes the impact of fresh foods and energy, fell to 2.4% in April, down from 2.9% in March. It was the lowest rate of core-core inflation since September 2022. Core-core inflation had peaked at 4.3% from June to September of 2023. 

By category, prices were up 4.3% for food, 2.2% for clothing, 1.2% for health care, 2.7% for transportation, 1% for communication, and 0.6% for housing. Meanwhile, energy costs declined, but by the smallest amount in 14 months as the energy subsidy was gradually phased out. 

In March, the BOJ ended the policy of negative short-term interest rates. In addition, it ended the policy of “yield curve control” in which it targeted the yield curve by trading in government bonds. Since then, the yield on the 10-year bond has hit 1%, the highest level in eleven years. Meanwhile, despite this policy, the yen has depreciated further, likely driven by expectations that the US Federal Reserve will delay policy easing until at least September. The most recent favorable inflation report likely reduces pressure on the BOJ to tighten policy further. However, concerns about the value of the yen could lead the Bank to act sooner than otherwise.   

US Federal Reserve commits to stay the course

  • At their meeting that concluded on May 1, the members of the Federal Reserve’s policy committee concluded that interest rates will have to stay high for longer to weaken the economy and reduce inflation. Yet they expressed uncertainty as to how effective the tight monetary policy would be in accomplishing their goals. This is according to the minutes of the last meeting. Notably, some members of the committee “mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such action became appropriate.” It is not clear how many members said this. 

However, Chair Powell has expressed a strong reluctance to consider raising rates again. Thus, the most likely path is to keep rates steady for several more months. One member, Christopher Waller, said that “we’re not seeing anything right now that looks like staying here for three or four months is going to cause the economy to go off a cliff.” Thus, as the Fed balances a desire to reduce inflation with a desire to avoid an economic downturn, it is clearly more focused on the inflation goal. 

Notably, the committee members said that service price inflation, which is the main inflationary problem right now, “could resume its decline as wage growth slows further with labor demand and supply moving into better balance, aided by higher labor force participation and strong immigration flows. In addition, many participants commented that ongoing increases in productivity growth would support disinflation if sustained, though the outlook for productivity growth was regarded as uncertain.” Thus, the trajectory of Fed policy will depend, in part, on what happens with labor force participation, immigration, and labor productivity. The members did suggest that supply and demand in the labor market are gradually coming together, auguring a further reduction in wage inflation.  

UK inflation numbers offer mixed signals

  • Inflation in the United Kingdom continued to recede in April, but not as much as had been hoped. In April, consumer prices were up 2.3% from a year earlier, the lowest rate since July 2021 when the inflation problem began. As such, inflation is now very close to the Bank of England’s target of 2%. Prices were up 0.3% from a month earlier. Meanwhile, when volatile food and energy prices are excluded, core prices were up 3.9% from a year earlier, the lowest since October 2021. Core inflation is a measure of underlying inflation and remains too high. Indeed, core prices were up 0.9% from the previous month. Thus, although political leaders welcomed the very low headline inflation, it is likely that the core inflation news was not welcome for the Bank of England.

The low headline inflation had much to do with a decline in energy prices. It was reported that gas prices were down 37.5% from a year earlier while electricity prices were down 21%. This was due to the government reducing the energy price cap. On the other hand, the price of petrol increased while prices of labor-intensive services were up 5.9%. Prices for restaurant and hotel services were up especially sharply, not surprising given the labor intensity of these industries. As is true in the Eurozone and the United States, it is service price inflation that is the principal concern of the central bank. In fact, although British headline inflation is lower than in the Eurozone or United States, service inflation in the United Kingdom is significantly higher than in the Eurozone or United States. 

Plus, it doesn’t help that labor productivity in the United Kingdom has been declining. If productivity were rising, then employers could boost wages without necessarily boosting prices. That would be due to a rise in the output generated by each worker. The opposite is now happening, leading employers to be more willing to boost prices to offset higher labor costs. Indeed, wage increases have been stronger than expected.

The higher-than-expected core inflation and service inflation led investors to expect the Bank of England to possibly delay interest rate cuts. This, in turn, led to a sharp rise in British bond yields and, therefore, an increase in the value of the pound.

US tariffs on Chinese EVs set the stage for further decoupling

  • During the Trump Administration, the US tariff on Chinese vehicles was increased from 2.5% to 27.5%. Now, US President Biden has announced tariff increases on Chinese imports of electric vehicles (EVs) as well as batteries, semiconductors, solar panels, port cranes, medical equipment, steel, and aluminum. The tariff on EVs will increase to 102.5%. Yet the total volume of imports that will be affected by these new tariffs is US$18 billion. This is much less than the US$300 billion in Chinese imports that were affected by the round of tariffs introduced in 2018. Still, the tariffs are likely meant to stifle a surge in imports of these products. 

While the tariffs on EVs will be quadrupled, tariffs on EV batteries will be tripled and other tariffs were doubled. The White House indicated that the intention was to focus narrowly on areas of concern. The head of the National Economic Council, Lael Brainard, said that the actions would “make sure that historic investments in jobs spurred by President Biden’s actions are not undercut by a flood of unfairly underpriced exports from China.”  

Currently, the US imports very few Chinese EVs. Yet there is concern that this could quickly change. Biden’s action comes as some members of Congress call for a complete ban on imports of Chinese EVs. Under the Inflation Reduction Act, the US government has provided significant subsidies to boost the domestic EV industry. Tariffs will be meant to protect this investment. This initiative comes following concerns that China is about to flood the global market with inexpensive EVs and other products. The US and EU claim that this is facilitated by subsidies by the Chinese government, effectively enabling Chinese producers to dump cheap products on global markets.  

On the other hand, Chinese companies say that their competitive pricing has nothing to do with excess capacity, as suggested by US and EU authorities. A Chinese government spokesman said that “China consistently opposes unilateral tariff increases that violate WTO rules and will take all necessary measures to safeguard its legitimate rights and interests.” It is reported that China has the capacity to produce over 48 million vehicles but is expected to produce 27 million this year. Part of this disparity has to do with the transition to EVs. Moreover, China is developing EV capacity quickly while the increase in demand is expected to evolve gradually in the coming decade. 

The problem with higher tariffs is that they will likely result in higher prices paid by US consumers, not only for imported products but also for domestically produced products that will not face significant competition. Not only does this mean that consumer purchasing power is effectively reduced; it also likely means reduced overall demand for EVs. This slows the move to clean energy, the opposite of what was intended by the Inflation Reduction Act. 

Meanwhile, China does not intend to stand still. A spokesman for China’s Foreign Ministry said, “We urge the US to follow WTO rules, lift all additional tariffs on China [imposed in 2018 and 2019 by former President Donald Trump] and not to impose new ones.” He said that “China will take all necessary measures to defend its rights and interests.” However, how China responds will depend on what it thinks it can accomplish and on how extensive are the US actions. 

Still, the tariff announcement in the United States will not have an immediate impact on China. That is because the volume of Chinese exports to the United States that were affected is relatively small. Yet the tariffs will likely restrain future growth of such exports to the United States. This is worrisome for Chinese producers at a time when China is making a massive investment in EVs and related technology. Exporting is meant to play a key role in absorbing the added output, at least before China’s domestic demand catches up. 

Moreover, the US example will likely play a role in the deliberations of the European Union (EU). The EU is investigating Chinese dumping of EVs and other products. The result of this investigation could be a decision to impose new tariffs on imported Chinese EVs. If the EU joins the United States in imposing punitive tariffs, then Chinese producers of EVs will have to focus on emerging markets and the domestic Chinese market. 

The new tariffs are part of a larger effort by the United States and EU to decouple from China. Although the United States says that the goal is to de-risk supply chains, the reality is that the tariffs, combined with previous actions limiting trade and cross-border investment in technology, is causing a fragmentation of the global economy, with Chinese direct economic relations with the West being diminished. 

How will China respond? It could retaliate by imposing tariffs on imports from the United States. Yet if it boosts the domestic price of needed inputs, such as technology products, this could hurt China. It could impose tariffs on agricultural products. Or it could boost subsidies to offset the impact of tariffs. Yet that would likely invite more protectionist measures, not only by the United States and EU, but also by emerging countries that might feel threatened by a flood of cheap Chinese goods.  

US inflation falls while retail sales stagnate

  • The inflation data released last week by the US government helped to restore confidence that inflation is declining. The data shows a notable deceleration in both headline and core inflation. In response, the yield on the US government’s 10-year bond fell sharply. That, in turn, led the Japanese yen and other currencies to appreciate sharply. Yet the favorable inflation data will likely only be impactful if it is the start of a trend. If so, it could change the trajectory of Federal Reserve policy. It is too soon to know. In any event, let’s look at the numbers.

In April, US consumer prices were up 3.4% from a year earlier, down from 3.5% in March. Having bottomed at 3.1% in January, inflation accelerated for two months before receding in April. Prices were up 0.3% from March to April. Yet, what matters more is the direction of core inflation, which is a measure in which volatile food and energy prices are excluded. In April, core prices were up 3.6% from a year earlier, down from 3.8% in March and the lowest rate of core inflation since April 2021. Core prices were up 0.3% from the previous month, the smallest monthly increase since December. 

There were many categories that had either very low or even negative inflation. For example, prices of both new and used cars were down from a year earlier. Prices of food eaten at home were up only 1.1% while prices of food away from home were up 4.1%, a reflection of the labor-intensity of the food service industry. Prices were down 2.8% for household furnishings, down 8.2% for televisions, and down 9.8% for smartphones. And prices were down 5.8% for airline fares. On the other hand, prices were up 5.5% for shelter, up 7.7% for hospital services, and up 22.6% for motor vehicle insurance.

Most importantly, and consistent with recent months, inflation remains mainly a problem of services. Prices of durable goods were down 3.2% from a year earlier while prices of non-durables were up only 1.8%. Yet prices of services were up 5.3%. Services are mostly labor-intensive, and the US labor market remains tight—although it has loosened somewhat in recent months. In addition, wage inflation has receded somewhat. 

In response to the favorable inflation data, the US dollar depreciated against major currencies, the yield on the US 10-year bond fell, and US equity prices increased. Investors now mostly expect either one or two interest rate cuts by the Federal Reserve this year, most likely starting in September. Moreover, the recent report likely reduces substantially any expectation that the Fed will hike rates this year.

  • Meanwhile, another piece of data was released that reinforces the impact of the inflation data. That is, the government reported that retail sales in April were unchanged from the previous month. This data is in nominal terms (not adjusted for inflation). Retail sales mainly involve the sale of goods, not services. With nearly no inflation in goods, this suggests that, in real terms, retail spending was roughly flat in April. This indicates some weakening of the consumer sector of the US economy. On the other hand, a much larger share of consumer spending involves non-retail services, where spending has lately been increasing. Thus, the retail sales numbers must be taken with a grain of salt.

Here are the details: In April, retail sales were unchanged from March and up 3% from a year earlier. From the previous month, spending on motor vehicles was down 0.8% while spending on furniture and home furnishing was down 0.5%. On the other hand, spending at electronics and appliance stores was up 1.5% while spending at building materials stores was up 0.5%. Spending at clothing stores was up 1.6% while spending at department stores was up 0.5%. Interestingly, spending at non-store retail venues (internet and catalog) was down 1.2%.  

China rebounds modestly while economic data is mixed inflation

  • China no longer faces deflation in consumer prices, but inflation remains very low. Moreover, producer prices continue to fall, suggesting that excess capacity is a problem. The good thing is that, with weak inflationary pressure, the central bank has leeway to further ease monetary policy if needed. On the other hand, it is likely that use of fiscal rather than monetary policy would be more effective in boosting economic growth, especially if investors are unresponsive to lower interest rates. Indeed, the government in Beijing intends to issue a new tranche of bonds, which amounts to a fiscal stimulus.

Let’s look at the details. First, in April consumer prices in China were up 0.3% from a year earlier, the third consecutive month in which prices rose from a year earlier. This followed four months of deflation. Prices were up 0.1% from March to April. From a year earlier, inflation varied by category. Prices of non-food goods and services were up 0.9% while prices of food were down 2.7%. When volatile food and energy prices are excluded, core prices were up 0.7% from a year earlier and down 0.6% from the previous month. 

Meanwhile, producer prices (often known as factory gate prices) were down 2.5% in April versus a year earlier, the 19th consecutive month of decline. Producer prices were down 0.1% from the previous month. From a year earlier, raw material costs were down 1.9% while the cost of processing materials into products fell 3.6%. In addition, the producer price of consumer goods fell 0.9% from a year earlier, including a 1.9% decline in the price of durable consumer goods. The persistent decline in producer prices is likely an indication of excess capacity, with producers struggling to unload excess inventory. 

Finally, the decision by the government to sell a large volume of bonds is not only a potential fiscal stimulus. It could also be an effort to boost the liquidity of capital markets, increasing their role as an alternative to bank lending. Specifically, the government likely wants to ease the process by which favored technology companies raise funds in capital markets, thereby fulfilling the government’s goal of boosting the role of emerging technologies in China’s economy.

  • While some analysts and politicians contend that China is afflicted with excess capacity, which is suppressing inflation, China says otherwise. Yet the latest monthly data on China’s economy indicates a strengthening of output but a weakening of consumer demand. That, of course, is a recipe for excess capacity barring a surge in exports. Meanwhile, although investment in residential property continued to fall sharply, other forms of investment grew rapidly, fueled by government support for infrastructure and key areas of manufacturing. Here are the details.

In April, retail sales were up 2.3% from a year earlier, lower than the 3.1% gain in March and the lowest rate of expansion since December 2022. While spending on grain and food oil (up 8.5%), home appliances (up 4.5%), and communications equipment (up 13.3%) grew strongly, many other categories experienced decline. These included clothing (down 2%), automobiles (down 5.6%), and building materials (down 4.5%). 

On the other hand, industrial production was up 6.7% in April versus a year earlier. In four of the last five months, output grew more rapidly than at any time since early 2022. Manufacturing was up 7.5%. Moreover, given that the government is encouraging increased output of technology and EVs, it is not surprising that output was up 15.6% for communications and computers and up 16.3% for automobiles. Also, output of chemicals was up 12.3%. 

Meanwhile, in the first four months of this year, fixed asset investment was up a moderate 4.5% from a year earlier. Investment was weighed down by the 9.8% decline in investment in property. Excluding this, overall investment was up a strong 8.9%. As for residential property, it was also reported that new home sales, measured by floor area, were down 23.8% in the first four months of this year versus a year earlier. The average price of a new home fell 3.1% in April versus a year earlier, the biggest decline since July 2015. Prices fell far more sharply in Shenzhen (down 6.7%) and Guangzhou (down 6.9%) but increased in Shanghai (up 4.2%) and fell modestly in Beijing (down 0.5%). Declining home prices have probably led some households to boost savings.

The data presented here is consistent with the idea of excess supply. The problem, then, for China is that, absent the ability to export large amounts of the increased output, the country will likely wind up with excess inventories and downward pressure on prices. Yet given increasing protectionist sentiment, not only in the United States and Europe but also in some large emerging markets, export growth could be problematic.

Finally, although China is intent on shifting growth away from property and toward investment in new technologies, there remains a problem in the residential property market. As such, the central bank said it is setting up a US$41.5 billion program meant to “digest” the excess supply of housing. The program will work like this: The central bank will provide low interest loans to banks, which in turn will lend money to state-owned enterprises that will purchase homes that have been completed but not sold. Instead, these homes will be provided to low-income households through subsidies. By taking excess capacity off the market, the hope is that this program will help to stabilize home prices.

China faces a labor shortage in manufacturing

  • One reason China grew so rapidly in the last 40 years was that it saw an enormous migration of workers from rural to urban areas. Moving a worker from a farm to a factory generally leads to a big increase in labor productivity. China’s rapid growth was largely fueled by such productivity gains. However, in recent years, the pace of migration slowed, and in fact there is evidence that it may be reversing. This is an important reason why China is growing more slowly than previously. 

Meanwhile, the large pool of migrants is aging. Of the roughly 297 million migrants working in China’s urban areas, 31% are over 50, about three times the share in 2008. The average age of the migrants is 43, up from 34 in 2008. As workers age, many are shifting from manufacturing work to less labor-intensive service work. And some are simply retiring. One result is that the share of migrants working in manufacturing has fallen from 38% in 2008 to 28% now.  

The situation with migrant workers is causing a shortage of labor for the vast manufacturing sector, even though manufacturing employment has been declining for the last two decades. The aging of migrants is not the only reason. Another is that an increasing share of urbanites are obtaining university degrees, many of whom prefer to take white collar jobs in the services sector. 

The shortage of labor in the manufacturing sector has led to a sharp rise in the cost of labor. According to the Japanese government, base compensation at Japanese-owned factories in China is now 40% higher than at Japanese factories in Thailand. Ten years ago, they were the same. Thus, labor arbitrage is no longer a good reason to invest in China. Moreover, the evident shift of supply chains away from China and toward Southeast Asia is not only about geopolitical risk. It is also about labor costs. China’s government, meanwhile, is promoting manufacturing in high technology and clean energy, likely exacerbating the shortage of labor.  

Chinese trade patterns continue to shift

  • China’s exports grew modestly in April after having fallen sharply in March. When measured in US dollars, Chinese exports fell 7.5% in March versus a year earlier. In April, exports were up 1.5%. The rebound was principally because of stronger demand for automobiles and other high-tech products but was offset by weaker demand for apparel and steel.

In line with recent trends regarding changed trade patterns, Chinese exports were up 4% to Taiwan and 8.1% to Southeast Asia. That is, Chinese trade with neighbors other than Japan is rising. On the other hand, exports were down 10.9% to Japan, down 2.8% to the United States, and down 3.6% to the European Union (EU). Exports to Australia, South Korea, and Russia were down as well. Thus, it appears that trade with Southeast Asia was the reason for China’s overall growth. Also, export growth was helped by a low base from a year earlier. That is one reason to expect weakness in export growth in the months ahead.

Meanwhile, imports were up 8.4% in April versus a year earlier, the second biggest increase since February 2022. It has been reported to be largely due to a surge in demand for AI-related equipment. Imports of automatic data-processing equipment, which includes computers and components, were up 50% in the first four months of 2024 versus a year earlier. This reflects the effort of Chinese companies, encouraged by the government, to quickly become a major force in gen AI. Meanwhile, many other import categories declined, including agricultural goods, coal, and cosmetics. 

By country, April imports were up 9% from the United States, 2.5% from the EU, and 5% from Southeast Asia. In the first four months of 2024, imports were up strongly from Taiwan, Southeast Asia, South Korea, India, and Hong Kong. Imports from the United States, EU, and Japan were down.  

The latest on European-Chinese economic relations

  • “The world cannot absorb China’s surplus production.” So said EU Commission President Ursula von der Leyen after meeting with China’s president in Paris. A serious trade dispute seems to be bubbling between China and the EU. China’s strategy for economic growth party involves boosting investment in key technologies, including electric vehicles (EVs) and related products. Yet China’s strategy does not include boosting consumer demand within China. Thus, the only way to justify the extra production is to export. 

Meanwhile, the EU is concerned about a flood of inexpensive EVs and other products entering the European market. The EU worries that China is dumping (selling below cost due to government subsidies). China’s producers say that they are simply good at producing low-cost and high-quality vehicles. The EU is investigating China’s imports and could decide to impose restrictions. In response, China is investigating dumping of EU products in China, such as high-end alcoholic beverages. 

At the meeting in Paris, both von der Leyen and French President Macron urged China to ease entry of EU goods in China and reduce regulations that are seen as protectionist. Von der Leyen hinted that protectionist measures could be necessary to defend EU companies and economies. On the other hand, the French worry that Germany might undermine the EU investigation into dumping because of German reliance on exports of automobiles to China. One solution to the perceived imbalance is for Chinese EV producers to invest in production in Europe. Indeed, French Finance Minister Le Maire said that “BYD is welcome in France,” referring to the China-based EV producer. BYD is planning to build a factory in Hungary. 

In any event, trade tensions between China and the EU, as well as between China and the United States, are likely to persist so long as China follows its current policy. This policy places strong emphasis on moving China up the value chain by investing in key technologies but does not include policies meant to absorb excess production in domestic markets. At the same time, protectionist sentiment in both Europe and the United States is on the rise, fueled in part by geopolitical concerns about China’s rise, but also due to a desire to boost domestic capacity in key technologies. 

  • Meanwhile, European companies are increasingly pessimistic about doing business in China, according to a survey conducted by the European Union Chamber of Commerce in China. According to the survey, only 15% of respondents said that China is a top investment priority—a record low. Also, only 13% said that China is their top future destination—also a record low. Meanwhile, 68% of respondents, a record high, said that doing business in China has become more difficult. On the other hand, 45% said that there has been market opening in their industry.

The pessimistic viewpoint reflects several factors. The Chamber reported that “China’s structural issues—including sluggish demand, growing overcapacity and the continued challenges in the real estate sector—along with market access and regulatory barriers, continued to negatively impact European companies.” Indeed, 55% of respondents said that China’s slowdown is among their top three business challenges. That was up from 36% a year ago. Of particular note is the concern about overcapacity in China, which means that European companies are facing significant competition from Chinese companies. 

In response to the perceived challenging environment, 52% said that they plan to cut costs in China, with 26% planning to reduce headcount. In addition, 13% said that they are already taking steps to exit investments out of China. Still, 42% are considering expanding investments in China. Yet that is a record low. The survey results could partly explain why there has been a sharp decline in inbound foreign direct investment into China.  

Bank of England leaves rates unchanged

  • The Bank of England (BOE) left the benchmark interest rate unchanged at 5.25% but strongly signaled a possibility that the rate will be cut in June. Andrew Bailey, governor of the BOE, said that “it’s likely that we will need to cut bank rates over the coming quarters, possibly more so than currently priced into market rates.” He said that a cut in June cannot be ruled out but that it is not a fait accompli. The vote to leave the rate unchanged was seven to two, with the two wanting to cut the rate. At the previous meeting, there was only one member of the committee voting to cut. Thus, sentiment is evidently shifting. 

Meanwhile, the BOE offered a slightly more optimistic forecast about the trajectory of inflation than in February. Bailey said that, although he is optimistic that inflation is moving in the right direction, the committee will need to see more evidence of progress before cutting rates. The committee said that it will look at “forthcoming data” to determine if persistent inflation is receding. 

In addition, Bailey said that decisions will, in part, be dependent on how the BOE sees the labor market. However, the BOE indicated that there is “considerable uncertainty” about the reliability of official labor market statistics. This makes it more difficult to assess whether the labor market is becoming less tight, which is seen as necessary before cutting interest rates. 

Whatever the BOE decides in the coming months, it will surely have a political impact within the United Kingdom. The government of Prime Minister Sunak is eager to demonstrate that interest rates are declining before it faces voters in an election that must be held no later than January. Moreover, there is the issue of whether the BOE cuts rates before the European Central Bank (ECB). Already two major European central banks (Switzerland and Sweden) have cut rates, but a reduction by the BOE before the ECB will put downward pressure on the pound. That could be inflationary.  

British economy starts to recover

  • First-quarter data suggests that the British economy is starting a strong recovery. The government reports that, in the first quarter, real GDP increased 0.6% from the previous quarter. This follows two quarters of negative growth and was the fastest growth of GDP since the fourth quarter of 2021. Real GDP was up only 0.2% from a year earlier. 

When looking at GDP from the supply side of the ledger, output of services was up 0.7% from the previous quarter. The biggest contributor was a 3.7% increase in transport and storage services, led by a big increase in land transport services via pipeline. The second biggest contributor to services growth was a 1.3% increase in professional, scientific, and technical activities. 

Production was up 0.8%, which included a strong 1.4% increase in manufacturing output. That, in turn, was fueled by a big 5.7% increase in output of transport equipment, including automobiles. This was offset, however, by a 0.9% decline in construction activity. 

On the demand side, real consumer spending was up a modest 0.2% from the previous quarter. Gross fixed capital formation was up a strong 1.4%, which included a 0.9% increase in business investment. Government purchases were up 0.3%. Finally, net trade made a positive contribution to GDP growth as imports fell 2.3%, more than the 1% decline in exports.

Thus, Britain has exited recession. Moreover, Britain’s first-quarter growth was stronger than that of the Eurozone or the United States. The rebound was good news for the government, which hopes to offer voters evidence of economic strength later this year. On the other hand, after three quarters in which real GDP did not grow, real GDP has barely grown over the course of a year.  

US investors keep shifting their expectations about the Fed

  • In the past two weeks, investors have revised their expectations regarding Federal Reserve policy. The futures markets’ implied trajectory of short-term interest rates has shifted, with investors now expecting the Fed to loosen monetary policy a bit faster than had been expected two weeks previously. Why? The latest data on the US jobs market convinced many investors that the labor market is starting to loosen, even though it remains historically tight. Last week’s slower-than-expected job growth, combined with a decline in the job openings rate and the slower-than-expected GDP growth in the first quarter, suggest the possibility that the Fed’s tight monetary policy may finally be having an impact. This, in turn, suggests that inflationary pressures may ease in the months to come, and likely allowing the Fed to cut rates a bit faster than previously anticipated. 

The change in investor expectations explains why the yield on the US Treasury’s 10-year bond has fallen slightly. This follows a period in which the yield increased when many investors became convinced that the Fed wouldn’t cut rates soon. Investors were influenced by the surprising strength of the economy and the persistence of inflation. Now, however, they are starting to see indications of slower growth, if not an easing of inflation. Also, revised expectations of Fed action also explain the modest upturn in US equity prices. Finally, the Japanese yen has appreciated. This was likely due to intervention by Japan’s authorities, but it might have been influenced as well by changing expectations of Fed policy. 

Another data point that might spook investors is a sharp decline in US bank lending in the first quarter. It is reported that, in the first quarter of this year, bank lending declined US$36 billion from the previous quarter, the sharpest decline in three years. The decline was mainly due to a drop in credit card lending. Lending to businesses, including for commercial property, was up. The drop in credit card lending follows a period in which credit card debt increased sharply from the historic lows that followed the pandemic.

The decline in credit card debt in the first quarter could presage an easing of consumer spending growth. Delinquencies on credit card debt are now at the highest level in 13 years (although much lower than the peak reached during the global financial crisis), suggesting that an increasing number of households are feeling financial stress. This is despite low unemployment and rising real wages. Part of the problem is that the average interest rate on credit card balances is at an historic level.

US GDP and job growth decelerate, but inflation is stuck

  • The US government reported that real GDP grew at an annualized rate of 1.6% in the first quarter of 2024, slower than investors had anticipated and the slowest rate of expansion since the second quarter of 2022. The relatively weak growth was mainly due to a decline in business inventories, a decline in Federal government purchases, and a sharp rise in imports that led to a negative net contribution from trade. Other components of GDP did well. This included consumer spending, business investment, and investment in residential property. Here are the details.

In the first quarter, real (inflation-adjusted) consumer spending grew at an annualized rate of 2.5% from the previous quarter. This included a 1.2% decline in spending on durable goods (fueled by a sharp drop in automotive spending), no change in spending on non-durable goods, and a big 4% increase in spending on services. 

Real business fixed investment increased at a rate of 2.9%. This included a 2.1% increase for business equipment (the first increase in three quarters, fueled by investment in information technology and offset by a sharp drop in investment in transportation equipment), a 0.1% decline for structures, and a 5.4% increase for intellectual property (which includes software and R&D). Real investment in residential property was up at a rate of 13.9%. On the other hand, a decline in business inventories reduced real GDP growth by 0.35 percentage points. The rise in investment in information technology was the strongest since the first quarter of 2022. This bodes well for demand for consulting services. 

Meanwhile, although real exports of goods and services were up 0.9%, imports were up 7.2%. This means that net exports made a negative contribution to GDP growth. In addition, while state and local government purchases were up at a rate of 2%, real Federal purchases were down 0.2%. 

Although real GDP grew more slowly than expected in the first quarter, the core components did very well. Final sales to private domestic purchasers (which excludes the impact of trade, government, and inventories) were up at a rate of 3.1%. This was the second-fastest rate of growth since the fourth quarter of 2021 when the economy was bouncing back from the pandemic downturn. Thus, the news on economic growth remains relatively good. Moreover, the news suggests that the United States remains a prime engine for global economic growth. Still, the weak headline number evidently spooked investors. 

  • The US government also published data on household income, consumer spending, and the Federal Reserve’s favorite measure of inflation. Although the news on household spending was good, investors mainly focused on the inflation numbers. 

Specifically, it was reported that the personal consumption expenditure deflator (PCE-deflator) was up 2.7% in March from a year earlier, up from 2.5% in February. This was the first acceleration in the index since September 2023. However, when volatile food and energy prices are excluded, the core PCE-deflator was up 2.8% in March versus a year earlier, the same as in February. Core inflation has been relatively steady for four months, suggesting that the previous deceleration has halted. 

The inflation problem remains one of services, which are labor intensive. Thus, the problem is the tight labor market, which is generating significant wage gains. Specifically, prices of durable goods were down 1.9% from a year earlier while prices of non-durables were up only 1.3%. This included food, which was up just 1.5%. Yet prices of services were up 4% from a year earlier, roughly unchanged over the past five months. 

As such, it is not surprising that futures prices are implying a 60% probability that the Fed will start cutting rates in September. Plus, they imply only a 50% chance of a second rate cut in 2024. This is a sea change from just a few months ago when investors expected the Fed to start in June and undertake three to four cuts in 2024. The shift in investor expectations reflects the persistent tightness of the labor market and strong underlying demand in the economy. Investors evidently believe that the Fed will not loosen monetary policy while the economy is so strong and underlying inflation is stuck. 

Meanwhile, the US government also reported that, while real disposable personal income was up 0.2% from February to March (the fastest growth since December), real personal consumer spending was up 0.5%, the same as in the previous month. Thus, households continue to reduce savings to enable strong increases in spending. The personal savings rate fell from 3.6% in February to 3.2% in March. 

  • The Federal Reserve intends to keep interest rates high for longer, largely because the US labor market has remained unusually tight, thereby generating wage gains that propel inflation in services. Thus, any indication that the labor market is loosening would be welcome news for the Fed. The latest data suggested that labor market tightness is easing. The government reported a sharp slowdown in employment growth in April, although it remains higher than the expected long-term trend. Plus, wage growth in April receded. Let’s look at the data.

The US government report on employment includes results from two surveys: one is a survey of households, and the other is a survey of establishments. The establishment survey found that, in April, 175,000 new jobs were created. This was the slowest job growth since October 2023. On the other hand, the growth for March was upwardly revised to 315,000, an unusually strong number. One month does not make a trend. However, if the slower growth seen in April persists in the months to come, it will likely signal an easing of labor market tightness. That, in turn, might influence the decisions of the Federal Reserve.

By industry, there was very modest job growth in goods-producing industries (mining, construction, manufacturing). There was a decline in employment in information as well as professional and business services and there was very modest growth in financial services, leisure and hospitality, and government. Moderately strong growth took place in wholesale trade, retail trade, and transportation. But the strongest growth took place in health care and social assistance. Overall, April was a relatively poor month for job growth. 

The establishment survey also includes data on wages. The report says that, in April, average hourly earnings of all workers were up only 3.9% from a year earlier, the smallest increase since March 2021. Thus, wage pressure is evidently easing. However, it remains too high given the Fed’s goal of 2% inflation. If productivity were rising rapidly, then businesses could increase wages without increasing prices as they would be getting more out of each worker. Yet as indicated below, productivity growth stalled in the first quarter. 

Finally, the household survey indicated that, in April, employment grew more slowly than the labor force, thereby leading to an increase in the unemployment rate to 3.9%, still a very low level. 

  • The US government also reported on labor productivity in the first quarter. Recall that, in the three most recent quarters, labor productivity (output per hour worked) increased rapidly. This was helpful in reducing inflation. It also contributed to strong economic growth. The rise in productivity in 2023 was likely related to business investments in labor-saving and labor-augmenting technologies, a response to the tight labor market. 

Yet, in the first quarter of 2024, labor productivity nearly stalled. Productivity increased only 0.3% from the fourth quarter of 2023 to the first quarter of 2024. This followed strong growth of 3.5% in the previous quarter. The result was that, with wages continuing to rise, unit labor costs (ULCs) accelerated sharply in the first quarter. ULC denotes the labor cost of producing a unit of output. It is calculated as real (inflation-adjusted) hourly compensation divided by productivity. Thus, if productivity rises at the same rate as real wages, then ULCs are unchanged. That implies that companies needn’t raise prices in line with wage increases. 

In the second half of 2023, ULCs were basically unchanged as productivity gains offset real wage gains. Yet in the first quarter, ULC was up 4.7% from the previous quarter. Moreover, ULC was up faster for services than for manufacturing. This is not good news for suppressing inflation, especially given that most of the remaining inflation is the services sector.  

Federal Reserve indicates that rates will remain high for longer

  • As expected, the US Federal Reserve left its benchmark interest rate unchanged for now. However, Fed Chair Powell indicated that inflation has been more persistent than anticipated. He said: “It’s likely to take longer for us to gain confidence that we are on a sustainable path to 2% inflation. I don’t know how long it will take.” Consequently, he said that rates will remain high for longer. On the other hand, he said that the Fed will soon start to lighten its program of quantitative tightening. That is, it will slow the pace of asset sales. Doing so will put downward pressure on bond yields. Moreover, he said that an increase in interest rates is “unlikely.” 

Investors were evidently not surprised by this announcement. Bond yields and equity prices moved very little. Investors had already shifted their expectations based on the latest data on inflation and economic growth. 

Although Powell said that rates will remain high for longer, it is not clear if the current level of rates is having the necessary dampening effect on labor markets. As I note below, the job openings rate has been declining, indicating an easing of the tight labor market. Yet that might not be the result of Fed policy. There are likely other factors at work. Still, given the surprising strength of the US economy and US labor market, and given that core inflation has stabilized at a rate too high for comfort, it would likely not make sense for the Fed to cut rates at this time.  

One result of the new trajectory of Fed policy will likely be higher bond yields in the coming year than would otherwise be the case. Indeed, bond yields have risen in the last few months due to changing expectations about Fed policy. Higher yields will likely have a negative impact on merger and acquisition transactions. Moreover, the longer the yields remain high, the bigger the impact as businesses face the need to roll over debts. 

Eurozone economy accelerates while inflation recedes

  • The Eurozone economy finally accelerated in the first quarter of 2024 after a prolonged period of stagnation. In the first quarter of 2024, real GDP was up 0.3% from the previous quarter, the strongest rate of growth since the third quarter of 2022. Real GDP was up 0.4% from a year earlier. 

By country, the quarter-to-quarter growth of real GDP was 0.2% for Germany and France, 0.3% for Italy, and 0.7% for Spain. Most notable was the sharp rebound of the German economy, which had seen real GDP decline 0.5% in the previous quarter. German GDP growth in the first quarter of 2024 was the strongest in since the first quarter of 2023. Germany’s government attributed the rebound to strong business investment and exports. These offset weakness in consumer spending. In addition, Italy’s relatively favorable performance was, in part, related to strong exports. 

Going forward, there is reason to expect continued modest growth of the Eurozone economy. Real (inflation-adjusted) wages are rising, thereby creating the conditions for a boost to consumer spending. In addition, an expected easing of monetary policy by the European Central Bank (ECB) will likely have a positive impact on investment and interest-sensitive consumer spending. Meanwhile, a strong US economy and better-than-expected economic performance in China can help to stimulate exports. 

  • Inflation in the Eurozone is getting better. Although headline inflation in March was unchanged from the previous month, core inflation continued to decelerate. This potentially sets the stage for an easing of monetary policy by the ECB. However, investors are increasingly expecting the ECB to wait a bit longer before acting. Here are the details.

In March, consumer prices in the 20-member Eurozone were up 2.4% from a year earlier, the same as in February. However, when volatile food and energy prices are excluded, core prices were up 2.7% in March versus a year earlier. This was the lowest core inflation since February 2022. Recall that core inflation peaked at 5.7% in March 2023. Thus, significant progress has been made. 

As in the United States, the main inflation problem is in services. While prices of non-energy industry products in the Eurozone were up only 0.9% from a year earlier, prices of services were up 3.7%. Europe’s labor market remains tight, generating wage gains greater than the rate of inflation, especially when it comes to labor-intensive services. This is the principal concern of the ECB. Still, given that underlying inflation continues to decline, and given that economic growth remains sub-par, it seems reasonable to expect the ECB to start cutting interest rates sometime this year. 

By country, annual inflation in March was 2.4% in Germany and France, 1% in Italy, 3.4% in Spain, 2.6% in the Netherlands, 4.9% in Belgium, and 0.6% in Finland. The numbers for Germany and Spain were higher than in the previous month. This raised questions as to whether inflation is becoming sticky. For the ECB, this implies that the last mile toward the 2% target could be difficult and might require tighter policy for longer. In response to the inflation news, bond yields in Europe were up as investors reassessed the timing of a rate cut.  

Mexico-China trade tensions increase

  • Geopolitical tensions and uncertainty have led to a decline in foreign direct investment in China, especially on the part of US-based companies. Global companies are diversifying supply chains with resilience and redundancy in mind. One country that has attracted attention is Mexico. That is because it has relatively low labor costs (lower than in China), low costs of transporting goods to the United States, free trade with the United States, and relatively good political relations with the United States. 

Consequently, some Chinese companies are investing in Mexico, importing components from China to be assembled in Mexico for export to the United States. The US Mexico Canada Agreement on trade requires that a certain amount of value added be created in Mexico for goods to qualify for tariff-free entry into the United States. Still, the United States has pressured Mexico about the surge in Chinese exports to Mexico. Notably, Chinese exports to Mexico were up 34.8% from 2022 to 2023. From China’s perspective, trade with Mexico serves two purposes. First, it contributes to the production of goods in Mexico that are exported to the United States. Second, Mexico is seen as a valuable market in its own right. 

Mexico, however, is concerned lest the United States clamp down on trade with Chinese entities based in Mexico. Already, Mexican-US trade has increased significantly, with Mexico now the largest trading partner for the United States. As such, Mexico is now imposing tariffs on imports from countries that do not have free trade agreements with Mexico. Mostly, that means China. The tariffs, ranging from 5% to 50% will affect 544 product categories including steel, aluminum, textiles, and apparel. 

Mexican tariffs come as other countries consider restrictions on trade with China. In many countries, there is concern that China is dumping cheap products on global markets due to excess capacity and weak domestic demand. For China, tariffs will likely damage the ability to boost exports as a source of economic growth.

Meanwhile, although the United States has expressed concern about Chinese investment in Mexico, the reality is that the numbers remain relatively small. In the first quarter of 2024, the United States accounted for 57% inbound foreign direct investment in Mexico, with Germany accounting for 17%. China, on the other hand, only accounted for 6%.


Ira Kalish

United States


Cover image by: Sofia Sergi