The risk of an inventory correction is rising

REAL ECONOMY BLOG | March 10, 2025

Authored by RSM US LLP

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 risk of a slower pace, below 1%.

As the trade deficit has soared …

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 of 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.

… inventories have risen …

Manufacturing inventory-sales ratios are notably higher relative to the pre-pandemic 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.

… most notably in manufacturing …

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 what would normally be expected, our analysis found.

… and among durable goods wholesalers …

Increased inventory-sales ratios showed significant increases in wholesalers of motor vehicle and parts, machinery, equipment and supplies, and lumber and construction equipment in both December and January. Furniture and home furnishing inventories increased as well. There was a significant decline in electric and electronic wholesale inventory-sales ratios.

… as well as nondurable goods wholesalers …

In the nondurable wholesale sector, there were significant increases in beer and wine inventory-sales ratio and in the miscellaneous sector in both December and January.

… but retail may be a different story

In the retail sector, inventories in December were across-the-board lower than what would normally be expected, perhaps a sign of concern over a downturn in consumer spending. Data for January was not available.

The takeaway

The prospect of tariffs presents two opposing concerns for businesses:

• Stocking up on inventories before the tariffs to avoid increased costs.
• Increased cost of supplies because of the tariffs, leading to diminished demand.

The increase in inventories at year-end suggests the former, with producers and wholesalers taking out an insurance policy on future business.

As to the potential of a drop in consumer demand, that could conceivably be dealt with by lowering input purchases at a later date.