Producers have prepared for tariffs by buying goods in advance.
The purchases are creating the conditions for a modest inventory correction should demand slow.
In the process, the trade-in-goods deficit has increased to record levels.
Producers and wholesalers have prepared for higher tariffs by buying goods in advance, which is creating the conditions for a modest inventory correction should demand slow.
The risk particularly applies to purchases of durables such as machinery and equipment, our analysis of inventory data shows.
It’s important to remember that 40% to 45% of imports are not the final products that consumers or businesses purchase. Instead, they are intermediate goods, or inputs used in the production process.
With the threat of trade taxes becoming increasingly real, firms have pulled forward their purchases of industrial supplies, capital goods and consumer goods from trading partners.
That pulling forward has sent the trade-in-goods deficit to record levels in recent months. It has also sent inventory levels rising in selected industries.
The interplay between the inventory buildup, which boosts gross domestic product, and a larger trade deficit, which reduces GDP, in the first quarter will most likely restrain growth later in the year as purchasing managers work off their existing stocks of intermediate goods.
In our view, the American economy is strong enough to absorb the volatility caused by the trade uncertainty. We expect GDP growth to decline to 1.5% in the current quarter, with a risk of a slower pace, below 1%.
By the second half of last year, the deficit in the trade in goods was surpassing the deficits of 2022, when the demand for imports surged as the pandemic recovery gathered momentum.
By this past December, the United States was posting a $122 billion deficit in the trade in goods, the largest monthly deficit in history, only to be surpassed by the January deficit of more than $155 billion.
Imports for intermediate goods have accelerated except for two categories: automobiles and auto parts, and food and beverages, our analysis found.
There was a 34% increase in the import of industrial supplies in January, an 8.3% increase in consumer goods, and a 5.5% increase in capital goods.
Manufacturing inventory-sales ratios are notably higher relative to the prepandemic era of just-in-time purchasing. This shift in structure was likely precipitated by the trade war in 2018 and the pandemic in 2020, which led to dramatic shortages of intermediate goods.
The increase in inventories was evident in the durable goods sector. The inventory-sales ratio for the manufacturing of durable goods was substantially higher in December and January than would normally be expected, our analysis found.
Inventory-sales ratios showed significant increases for wholesalers of machinery, equipment and supplies; motor vehicles and parts; and lumber and construction equipment in both December and January compared to pre-pandemic, nonrecession averages. Furniture and home furnishing inventories increased as well. There was a significant decline in electric and electronic wholesale inventory-sales ratios.
There were significant increases in the beer, wine and alcohol inventory-sales ratio and in the miscellaneous sector in both December and January.
In the retail sector, inventories in December were across-the-board lower than would normally be expected, perhaps a sign of concern over a downturn in consumer spending. Data for January was not available.
The prospect of new and higher tariffs presents conflicting concerns for businesses:
The increase in inventories at year-end suggests the former, with producers and wholesalers taking out an insurance policy on future business.
As for the potential drop in consumer demand, businesses could respond by reducing their purchases of input materials in the future.
