Assessing the Sustainability of the U.S. Current Account Contraction

The U.S. current account deficit narrowed sharply in the third quarter, but the story is one of compression, not cure. The headline figure showed a deficit of $226.4 billion, a narrowing of $22.8 billion, or 9.2%. More importantly, this marked the lowest level since the third quarter of 2023. Yet this contraction occurred against a backdrop of robust economic activity. The deficit's share of GDP fell to 2.9%, its smallest since early 2020 and down from 3.3% in the prior quarter. This juxtaposition-slowing trade gap amid strong growth-is the central puzzle.

The primary driver was a clear shift in the goods trade. The goods deficit narrowed to $267.4 billion from $270.4 billion. This compression was not a sign of healthier trade balances but a direct response to policy. Firms had pared back on imports after front-loading foreign purchases to dodge aggressive tariffs passed by the administration. The data supports this: goods imports fell $5.0 billion, pulled down by consumer goods, while the goods trade gap shrank. This is a classic case of demand being pulled forward, not reduced.

The context is critical. The deficit had been on a steep climb, widening by $188.5 billion, or 42.9%, to $251.3 billion in the second quarter before this reversal. The third-quarter contraction, therefore, looks more like a pause in an upward trend than a new equilibrium. The services surplus expanded, and primary income flows surged, but these offsets were secondary to the tariff-driven import pullback. The bottom line is that the current account's improvement is real but appears temporary, a statistical artifact of policy-induced import compression rather than a fundamental rebalancing.

The Tariff Distortion: Cyclical Pause vs. Structural Shift

The contraction in the U.S. current account is a story of policy-induced compression, not a fundamental shift in trade flows. The data reveals a clear, but temporary, pause driven by the International Emergency Economic Powers Act (IEEPA) tariffs. The goods deficit fell to $59.14 billion in October, down 24.5% from September and the smallest monthly figure since at least 2020. This sharp drop aligns with the timeline of tariff implementation, suggesting firms pulled forward purchases in early 2025 to avoid higher costs, then curtailed imports after the policy took effect. Yet this improvement is deeply distorted. The headline numbers are skewed by volatile, non-traditional items. In October, imports of nonmonetary gold declined $1.4 billion, a category that can significantly influence monthly trade totals. More broadly, the run-up in gold imports throughout 2025 has clouded the trade picture, making the deficit appear narrower than the underlying trade in goods and services might suggest. This volatility illustrates how specific categories can distort the narrative of a broader economic trend.

The bottom line is one of cyclical distortion, not structural rebalancing. The goods deficit remains enormous, projected to hit $1.26 trillion for 2025, larger than the previous year. The tariff-driven compression is a statistical artifact of front-loaded buying and policy uncertainty, not a sign that U.S. import demand is permanently cooling. As one economist noted, with an effective tariff rate between 12% and 16%, the current policy is not enough to reduce imports over time. The real test will be whether this compression holds if the Supreme Court upholds the IEEPA tariffs, or if the policy is reversed, allowing the pent-up demand to surge again. For now, the contraction looks less like a new equilibrium and more like a pause in a long-term deficit trend.

Financial Flows and the Primary Income Surge

While the tariff-driven compression of the goods deficit grabbed headlines, a parallel shift in investment income was critical in narrowing the overall current account gap. The primary income balance swung decisively to a surplus of $5.2 billion from a deficit of $5.8 billion. This reversal was the result of a powerful surge in receipts, which advanced $16.3 billion to $395.2 billion. The key driver was a rise in direct investment income, which helped push total receipts of primary income to $390.0 billion. This inflow of earnings from U.S. assets abroad provided a crucial offset, partially shielding the current account from a deeper contraction.

The durability of this offset, however, is questionable. The primary income surplus is inherently vulnerable to changes in global capital flows and corporate earnings. It reflects the returns on a vast stock of foreign assets held by U.S. investors, a position that can be sensitive to interest rate differentials, geopolitical risks, and the profitability of multinational enterprises. A sustained shift in global investment patterns or a slowdown in overseas earnings could quickly reverse this surplus. Unlike the tariff-induced compression of goods imports, which is a cyclical, policy-driven pause, the primary income flow is a structural component of the U.S. investment position. Its recent surge is a positive development, but it does not address the underlying imbalance in trade.

The secondary income account provided a minor, almost negligible, offset. The deficit narrowed slightly to $53.5 billion from $53.6 billion, a change too small to materially impact the overall picture. The focus remains on the primary income swing. For the current account contraction to be sustainable, this investment income surplus would need to persist alongside a fundamental reduction in the goods deficit. Given the evidence that the goods import compression is a temporary front-loading effect, the reliance on a volatile component of investment income for offset creates a fragile equilibrium. The bottom line is that the current account's improvement is being propped up by two distinct, and potentially fleeting, forces: a cyclical pause in imports and a structural but vulnerable flow of investment earnings.

Catalysts, Scenarios, and What to Watch

The sustainability of the current account contraction hinges on a few critical catalysts and policy decisions in the coming months. The framework for monitoring is clear: watch for the permanence of the tariff regime, shifts in emerging market trade dynamics, and the durability of the investment income offset.

The paramount catalyst is the potential permanence of the International Emergency Economic Powers Act (IEEPA) tariffs. Their continuation could sustain a new, lower plateau for the goods deficit. As one economist noted, if these tariffs remain intact, the U.S. is likely to see average monthly deficits in the $50 billion to $70 billion range. This would keep the annual goods gap below a trillion dollars, a significant improvement from the projected $1.26 trillion for 2025. The Supreme Court decision on the IEEPA's legality is expected imminently, and the outcome will dictate whether this compression is a lasting policy choice or a temporary pause. If the tariffs are struck down, the administration would face a fast reboot, and the pent-up import demand from the first quarter could surge again, reversing the recent gains.

A second watchpoint is broader emerging market trade dynamics, signaled by the upcoming review of the IMF agreement with Argentina. Argentina's program, which has delivered a primary fiscal surplus and is projected to generate a trade surplus in 2026, represents a potential model for other nations. Its recovery, led by energy and mining exports, could shift trade flows in the Americas. Monitoring the July 2026 review will provide early signals on whether this stabilization is holding and if it will lead to a reorientation of supply chains and trade balances that could indirectly affect U.S. trade flows.

Finally, the primary income surplus that has helped narrow the current account is structurally vulnerable. This surplus of $5.2 billion is driven by earnings on U.S. assets abroad and is sensitive to global capital flows and corporate profitability. The key metric to watch is direct investment income, which led the surge in receipts. Any sign of a reversal in this trend-due to slower overseas earnings, shifts in investment patterns, or changes in global interest rates-would quickly erode the offset that is propping up the current account. The bottom line is that the current account's improvement is being propped up by two distinct, and potentially fleeting, forces: a cyclical pause in imports and a structural but vulnerable flow of investment earnings. For the contraction to be sustained, both must hold.