The Federal Reserve's policy space is being squeezed again! The unexpected increase in the U.S. goods trade deficit in May reached a one-year high, and the second quarter GDP is feared to be dragged down.

Data released by the US Department of Commerce on Friday (June 26) showed that the US trade deficit in goods in May expanded significantly by 27.4% from the previous month, reaching $105.8 billion, the largest in over a year. This number far exceeded the median estimate of $85 billion made by economists, reflecting a severe deterioration in the US trade imbalance in May. Structurally, the significant divergence in the trends of imports and exports was a direct driver of the rapid expansion of the trade deficit. In May, US goods exports fell by 5.4% from the previous month, decreasing by $11.8 billion to $207.7 billion; meanwhile, imports increased by 3.6%, rising by $10.9 billion to $313.4 billion. The contraction in exports and the expansion in imports occurred simultaneously, leading to a rapid widening of the trade gap. US goods trade deficit expands to largest in over a year Export Plunge: end of the oil boom and weakening global demand The steep decline in exports in May was in stark contrast to the historic growth in April. Due to disruptions caused by the conflict with Iran and the near closure of the Strait of Hormuz, Middle Eastern oil supplies were disrupted, causing international oil prices to briefly exceed $100 per barrel. US energy producers took advantage of this situation to fill the market gap. In April, crude oil exports soared by 60%, driving overall export value up by 2.6% to a record level. Industrial goods (including petroleum products) dropped by 7.0% to $82.7 billion, becoming the largest factor dragging down exports. In April, disruptions due to the Iran war severely disrupted Middle Eastern trade, leading to a surge in US oil exports to a historic high. However, as peace talks between the US and Iran progressed and oil flow through the Strait of Hormuz gradually resumed, oil prices began to fall; at the same time, Asian fuel producers reduced their imports of US oil due to high transportation costs, collectively lowering energy exports in May. Consumer goods (excluding automobiles) plummeted by 9.2% to $20.7 billion, capital goods declined by 5.0% to $66.8 billion. Only food and beverages and automobiles saw slight growth, but the volume was far from enough to offset the decline in other categories. The sharp drop in capital goods exports in May further highlighted the fragility of export momentum, after capital goods exports had hit a record high in April. Imports surge: influx of AI equipment and precautious stockpiling drive growth In contrast to the overall weakness in exports, all major categories on the import side recorded growth. Consumer goods imports grew by 5.7% to $59.5 billion, reaching a six-month high. Another report released on Thursday showed that despite the fastest rise in prices in over three years, US personal consumption expenditure in May increased by 0.7%, demonstrating a steady domestic demand. Automobile imports grew by 6.3% to $36.9 billion, industrial goods grew by 4.8% to $55.9 billion, and miscellaneous goods saw a larger increase of 11.5% to $15.4 billion. Of particular note is the continued rise in imports of capital goods. In recent months, equipment for data centers has been flowing into the US continuously. In May, imports of capital goods (including computers and accessories, semiconductors, and telecommunications equipment) continued to grow, increasing by nearly 42% compared to the same period last year. An analysis by the Federal Reserve Bank of Minneapolis showed that by January 2026, the nominal amount of AI-related goods imported was 111% higher than the monthly average in 2023. AI capital spending is expanding from chip procurement to areas such as power, cooling, networking, data center construction, and grid infrastructure, becoming a persistent force driving changes in US import structure. Economists point out that pre-emptively increasing imports to avoid supply shortages and price increases due to the conflict in the Middle East was an important driver of the rapid expansion of the trade deficit this time. With supply chain delays becoming more common, companies have been hoarding goods and materials. Retail inventories grew by 0.6% in May, wholesale inventories grew by 0.3% month-on-month and by 4.3% year-on-year, posting the best 12-month growth in three years. However, the growth rates all slowed compared to the previous month, indicating that the inventory cycle may be approaching a temporary peak. Macroeconomic Impact: Significant Drag on GDP in the Second Quarter The sharp expansion of the trade deficit poses direct pressure on the US macroeconomy. The final value of US GDP for the first quarter was revised upward, partly due to the positive contribution from the downward revision in imports. However, the significant expansion of the deficit in May suggests that net trade will likely have a negative contribution to GDP in the second quarter, with trade components potentially becoming a drag on economic growth for the quarter. The drag effect of trade on GDP has been evident for two consecutive quarters. Currently, market estimates for annualized GDP growth in the second quarter are centered around 2.5%, with some economists suggesting that this estimate may be revised downward. The annualized growth rate for the US economy in the first quarter was 2.1%, and it was only 0.5% in the fourth quarter of last year. Abbey Omodunbi, senior economist at PNC Financial, pointed out: "Even though the deficit narrowed in May, the goods trade deficit has expanded by over 10% since March, making trade likely to be a drag on second-quarter economic growth." Market analysis points out that it will be important to monitor whether the expansion of the deficit is accompanied by passive accumulation of inventories, and whether it triggers a substitution effect for domestic production in response to imports - these will be key variables in assessing the sustainability of the US trade imbalance. The inventory data released on the same day showed how companies are responding to supply chain uncertainties. Retail inventories grew by 0.6% in May, higher than the market's expected 0.5%, but slower than the previous value of 0.7%. Wholesale inventories grew by 0.3% month-on-month, in line with expectations of the market, but significantly lower than the previous value of 0.6%. From a year-on-year perspective, wholesale inventories grew by 4.3%, marking the best 12-month growth in three years. This data confirms the trend of companies accumulating inventory since the outbreak of the conflict with Iran - as supply chain delays become more common, companies have been hoarding goods and materials, increasing concerns about further price increases. The slowdown in the growth of retail and wholesale inventories suggests that the inventory cycle may be approaching a temporary peak. It will be crucial to monitor whether the expansion of the deficit is followed by passive accumulation of inventories, and whether it triggers a substitution effect for domestic production in response to imports. More comprehensive trade data for May, including services trade balance, will be released on July 7. In the current macroeconomic environment, this trade data, which far exceeds expectations, further intensifies the market's speculation on the future of the US economy and policy path. The significant expansion of the trade deficit, combined with the continued rise in import prices, exacerbates inflationary pressures on the US economy. Data from the US Bureau of Labor Statistics shows that in May, import prices increased by 1.9% month-on-month, while export prices increased by 1.3%, with energy products being a core driver of the rising prices. Over the 12 months ending in May 2026, fuel import prices surged by 45.1%, with oil and natural gas import prices increasing by 48.1% and 35.3% respectively compared to the same period last year. Under the narrative of "inflation without stagnation", the policy space of the Federal Reserve is being continually squeezed. Despite a slight slowdown in core inflation in May and a temporary pause in market expectations of a rate cut, the resilience of import demand reflected in the expanding trade deficit and rising import prices adds new uncertainty to the inflation outlook. Currently, the market expects the Federal Reserve to raise interest rates at least once this year, with a 48.4% probability of a 25 basis point increase in September. The continued rise in imports reflects the resilience of domestic demand, but also implies a continued weakening of the contribution of trade to growth; the weakness in exports reflects the dual pressures of weakening global demand and changes in the energy landscape. After the release of the deficit data, discussions on the direction of Fed policy are expected to heat up - the contradiction between strong consumer spending and an expanding trade deficit is the reality that the Fed under Powell needs to face.