from Follow the Money

Record trade deficit, hedge funds turn into dollar bulls

October 12, 2006

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Those are two of the headlines on Reuters right now.   So much for the notion that hedge funds correct prices that deviate too much from fundamentals.   Slowing US growth, a widening trade deficit, buy dollars. 

The dollar did dip after the trade data was released, but not much.  I guess strong import growth could be interpreted as evidence that the housing slump hasn't spilled over into the broader economy.  But it also could be interpreted as evidence that (net) exports won't contribute positively to growth either.

The $70b ($69.9b) August trade deficit means the US is squarely on track for a $900b or so current account deficit this year.   The q3 trade deficit looks set to come in at somewhere between $205 and $210b.  Add in a $20b transfers deficit and a $10-15b income deficit and the current account deficit should chalk in somwhere between $235 and $245b.

And don't buy the spin that it is all just oil.  True, the price of imported oil was $66.12 this year.  It will be lower soon.   But the real story in the August data seems to be that non-oil import growth is picking up.  Non-oil goods imports were $133 in August, above their recent $128-29b range.   The y/y growth rate in non-oil imports was 9.85% in June, 10.8% in July and 13.4% in August.  

Memo to Stephen Jen: There is no way the trade deficit, let alone the current account deficit, can fall with those kinds of non-oil import growth numbers. 

Export growth continues to be strong, and strong across the board.  Exports to Europe (the EU) are up by 13.2%, only a bit less than exports to the Pacific Rim (up 13.8%).  

The country by country data also suggests a pickup in non-oil import growth.   Imports from China grew by about 20% y/y in August, up from 16% in July -- and faster than the 17% increase in the YTD number.   The 20% increase in US imports from China is still well below the 30% plus overall increase in Chinese exports in August, but it is consistent with the acceleration in the pace of export growth that shows up in the Chinese data.  And China's strong September export growth data suggests that the trend continued. 

More generally, very rapid growth in US imports from China hasn't led to a fall in US imports from the rest of Asia.   Imports from the rest of the Pacific Rim are up about 8% y/y.   That is consistent with the recent trend -- US imports from China are rising fast as a share of US GDP, while US imports from the rest of Asia are growing with US GDP.

I wonder if 2006 will shape up a bit like 2005.  In the first half of 2005, non-oil goods imports were stuck around $117b, but they jumped up at the end of the year.   For the first half of 2006, non-oil imports have been stuck around $127-129b.   They clearly jumped up in August.  And the broader data out of Asia suggests that may have continued in September.

An increase non-oil imports will be partially offset by a fall in the US oil import bill in q4, if current market prices hold.  But if non-oil imports continue to rise, there may be less improvement in the trade balance than many now expect.

Right now, market prices imply a q4 oil import price that will be well below the q3 average.  But current market prices don't imply much long-term relief.   Lest we forget, oil averaged about $52 a barrel in q1 2006. Current oil prices are still higher than the $46.8 average of 2005 -- and are only a bit lower than the $58.9 average price so far this year. They will bring down the q4 deficit relative to q3, but won't help much beyond that.

One last point.  I have noted previously that US oil import volumes (Exhibit 18) have been consistently below their 2005 levels in 2006.   For a while, the volume of US oil imports was running about 2% below its 2005 number.   My interpretation was that this was evidence that the US was cutting back on its demand for oil (marginally) in response to high oil prices. 

I may have to reconsider though.    Overall oil import volumes are still down about 1% for the year, but August/ July 2006 import volumes were up 2.6% over August/ July 2005 ...  I guess I should dig further though.  That may just reflect Katrina.

To sum up.  The August data shows strong export growth.  That isn't a change.  It shows high oil prices.  That isn't a surprise.  It also shows what could well be the beginning of a rise in non-oil imports.   That is a change -- there were hints of a rise last month, but not quite the clear evidence that shows up in the August data.   

As Menzie Chinn likes to point out, the "real" trade balance has been stable since the fourth quarter of 2005.  But if non-oil imports continue to grow at a 10% plus pace y/y, the real trade balance won't stay stable for long. 

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