Schwab Guide to Economic Indicators: Trade Balance

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Schwab Guide to Economic Indicators: Trade Balance
by the Schwab Center for Financial Research
November 30, 2007

What is it?
It's an international trade indicator that compares imports and exports of goods and services. The trade balance is expressed as a:

Trade deficit: where imports exceed exports

Trade surplus: where exports exceed imports

Other names for this report include:

Balance of trade
Trade deficit
Trade in goods and services
U.S. International Trade in Goods and Services

Because the United States has been running a trade deficit for many years, "trade deficit" has become the most common nickname for the report.

The report is jointly produced by the Bureau of Economic Analysis (BEA) and the U.S. Census Bureau.

What is its relative importance?
Medium. The report is monitored in conjunction with a variety of other economic indicators to help gauge the direction and strength of the economy, and what the Federal Reserve might do next with short-term interest rates.

This report has a drawback in that it's not as timely as other monthly economic indicators. The trade balance data is released approximately six weeks after the reference month. For example, data released in mid-March reflects January trade activity. That compares to a one-to-four week delay for a majority of the others. Therefore, its relative importance may decline in the face of fresher economic data.

What impact does it have on the market?
The following descriptions of economic and financial-market behavior are general in nature. See the "How is used?" section for more details.

A narrowing of the trade deficit can depict economic strength. A widening of the trade deficit can reflect economic weakness.

"Net exports" commonly describes the monthly change in the trade deficit. When exports exceed imports, net exports are growing. When imports exceed exports, net exports are contracting.

When the data shows "net-export growth," that describes a narrowing of the trade deficit during a given month. While unlikely to overcome the entire trade deficit, "net-export growth" is considered a positive influence on economic growth.

In contrast, a widening trade deficit (imports exceed exports) reduces gross domestic product (GDP).

The overall economic backdrop, and expectations of what is needed from monetary policy and where it's perceived to be headed play a major role with the direction of stock prices.

If the trend in the trade deficit narrows in a way that hints net-export growth is overheating, bond prices could fall (yields rise) on the outlook for greater overall U.S. economic output of goods and services, potentially higher inflation and an increased chance that the Federal Reserve will hike interest rates. Stock prices may also fall.

Why?

A rise in bond yields can eventually make bonds more attractive once the fall in bond prices settles down. Compared to where the weights of stocks and bonds were in your portfolio, the typical thing to do in response to this change in valuation would be to sell a portion of your stock portfolio and put the proceeds into bonds. Even if corporate profit growth seems supported in this time of strong net-export growth, the market will likely see it as being short lived given expectations for impending rate hikes and eventually slower economic growth.

There's a scenario where stock prices could experience a temporary lift if the economic backdrop is subdued. Suppose net-export growth comes to life in a manner suggesting the overall economy could be on the verge of rebounding from a weak period. This can give a boost to stock prices even with an expected rise in bond yields. That's because the market's expectation of potentially higher profit growth from greater economic demand can initially be the more influential factor in favor of higher stock prices. That is, for a period of time, it can be the more-dominant driver of stock prices, overshadowing the negative impact of rising bond yields (as discussed above).

While the renewed strength in net-export growth might suggest an eventual need for Fed rate hikes, it probably wouldn't be deemed immediate because of an otherwise weak economic backdrop. It would likely take some time for other economic reports to strengthen in order to validate the existence of an economic recovery.

A widening of the trade deficit could lift bond prices (reduce yields) based on expectations of slower economic growth and reduced inflation pressure. Suppose the economy is strong but monetary policy had recently become tight (restrictive). Stock prices could improve on hopes of a halt in the Fed's rate-hike campaign, along with the possibility of a future injection of economic stimulus if the next move by the Fed is a rate cut.

A widening of the trade deficit in conjunction with a weak economy probably wouldn't help stock prices. That's because the chance of recession and reduced corporate profits would likely be the dominant fears.

How is it calculated?
The BEA takes five-pages to describe how the trade balance is calculated. The following four paragraphs represent the key points:

"The Census basis goods data are compiled from the documents collected by the U.S. Customs Border and Protection and reflect the movement of goods between foreign countries and the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, and U.S. Foreign Trade Zones. They include government and non-government shipments of goods, and exclude shipments between the United States and its territories and possessions, transactions with U.S. military, diplomatic and consular installations abroad, U.S. goods returned to the United States by its Armed Forces, personal and household effects of travelers, and in-transit shipments. The General Imports value reflects the total arrival of merchandise from foreign countries that immediately enters consumption channels, warehouses, or Foreign Trade Zones.

"For imports, the value reported is the U.S. Customs Border and Protection appraised value of merchandise; generally, the price paid for merchandise for export to the United States. Import duties, freight, insurance, and other charges incurred in bringing merchandise to the United States are excluded.

"Exports are valued at the f.a.s. (free alongside ship) value of merchandise at the U.S. port of export, based on the transaction price including inland freight, insurance, and other charges incurred in placing the merchandise alongside the carrier at the U.S. port of exportation.

"Goods on a Census basis are adjusted by the U.S. Bureau of Economic Analysis to goods on a BOP (Balance of Payments) basis to bring the data in line with the concepts and definitions used to prepare the international and national accounts. Broadly, the adjustments include changes in ownership that occur without goods passing into or out of the customs territory of the United States. These adjustments are necessary to supplement coverage of the Census basis data, to eliminate duplication of transactions recorded elsewhere in the international accounts, and to value transactions according to a standard definition."

How is it used?
It is primarily used to help determine the value of the dollar. It also influences inflation, inflation expectations and economic growth.

The earlier descriptions of economic and financial-market behavior are general in nature. The trade balance requires special attention for a few reasons.

For starters, it's important to have an understanding of the trade balance with regard to the value of the U.S. dollar, net exports, the economy and inflation. Wider trade deficits can diminish the value of the dollar. Over time, this can eventually improve net exports and the growth of the economy. However, it can also increase import inflation. Conversely, narrower trade deficits theoretically improve the value of the dollar, hurt net exports and the economy, but soften import inflation. Yet these transitions typically take many months, possibly a year or two or more, to transpire.

In the short term, net-export growth tends to have a more direct influence on lifting near-term economic growth and inflation expectations. In the long run, however, contracting net exports and the associated widening of the trade deficit can raise the specter of undesirable increases of import inflation eventually showing up in the U.S. economy.

Strong imports can actually be a reflection of solid U.S. demand. Yet this condition also suggests foreign corporations may hold a competitive edge over U.S. counterparts. While supportive of the global economy, the immediate benefits for the United States (such as increased GDP and employment) would theoretically be less compared to when exports exceed imports.

When is it released?
The report is released approximately six weeks after the reference month and can be found on the BEA's home page. Click on "Trade in Goods and Services" for the latest report. It can also be found at the Census Bureau's home page within the "Economic Indicators" section. Under "select an indicator," click on "Trade Balance."

Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

(2007-5771)

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