Thoughts on trade

Last week, Macro Man was having a chat about the UK with one of his friends in the market. How could the Bank of England cut rates, this friend inquired, when the cost of living is rising so strongly, particularly the cost of energy? Ah, responded Macro Man, the price of energy has nothing to do with monetary policy and everything to do with Rip-off Britain, a view espoused in this very space a year ago this week.

So imagine Macro Man's surprise and pleasure when the Sunday Times published a report suggesting collusion on the part of UK power companies, and an accompanying editorial trumpeting the return of Rip-off Britain. As if one needed another reason to sell sterling.....

There have been some interesting developments in international trade recently which probably warrant comment. The most obvious is, of course, the much wider than expected US trade deficit in November. Now, one of the key planks in Macro Man's "US muddles through" view is that trade should contribute positively to growth. The sharp increase in y/y import growth is something of a base effect, given the massive y/y increase in the price of oil. Yet oil imports rose 17.3% m/m in November, and non-oil imports actually rose a percent as well. Meanwhile, export growth looks to be moderating; the export orders component of the ISM hardly suggest that December will post a strong rebound.

Either way, it's hard to construe the data as anything but dollar bearish; even if the bulk of import gains are from oil, the producers of the gooey black stuff have demonstrated a willingness to transfer some of their dollar receipts into European goods and financial assets. As such, the recent weakening of the buck looks pretty justified.

The US was not the only major country to report trade data at the end of last week. So, too, did China, and the details made fascinating reading. Exhibit A in the "currencies matter" department was the devleopment in Chinese trade with US; not only has China's surplus apparently peaked, but check out the recent trends in import and export growth! Obviously, imports are coming from a tiny base, and are perhaps distorted by political concessions and/or airplane orders. Neverthless, it's hard to avoid noticing that the faster the RMB's appreciation against the dollar, the faster US exports to China are growing relative to imports from China.

Interestingly, China's overall surplus is clearly showing signs of peaking. Despite the macro tightening in Q4 of last year, the narrowing appears to have via exports rather than imports; indeed, import growth is actually rising, perhaps courtesy of energy-related terms of trade. The common-sense explanation is that the weakness of the US consumer is having an impact, and perhaps there's something to that; neverthless, it's probably worth considering the impact of a slowdown in global trade.

Certainly the Baltic Dry Index is pointing to just such a development; after peaking in the autumn, the shipping index has corrected sharply lower. When that happened at the end of 2003, commodity-sensitive currencies like the AUD moved sharply lower.

Macro Man was (gently) chastised over the weekend for missing the boat on AUD, a charge that is probably justified on a backward-looking basis. Looking forward, however, the risks surrounding a deceleration in global trade and elevated financial market volatility make Macro Man wary of piling into high-beta trades like Ozzie. Saying that the US can avoid recession is not the same thing as saying that global growth will not slow, perhaps substantially.

For now, therefore, Macro Man prefers to play the short dollar view against the yen. Not only is the JPY the only G10 currency not overvalued against the buck on a PPP basis, but a secular rise in risk premia should make Mrs. Watanabe think twice before exporting as much capital in 2008 as she did in 2007.