Trade Balance

How the Trade Balance Relevant Affects the Forex Market

Every country produces goods and services to some extent, and these can either be consumed locally or exported to other countries for foreign exchange earnings.

However no country is entirely self-sufficient, and so will have to import goods and services that are lacking from other countries, paying those countries foreign exchange as a result. This constitutes the trade process that countries engage in. The comparison between the amount earned by a country from its exports and the amount spent on foreign exchange for imports is what is referred to as the balance of trade, or simply the Trade Balance.

The Trade Balance can therefore be defined as the difference in the value between exported and imported goods and services for a particular time period. In everyday economic parlance, this is sometimes referred to as trade deficit/surplus, with a deficit occurring if more goods and services were imported than exported, and a surplus occurring if more goods and services were exported than were imported.

As far as forex is concerned, the Trade Balance report is issued monthly, and covers the period of the previous month under review. It is released out of several countries, but the most important reports are released from the US, Canada, Australia, New Zealand, United Kingdom and China.

Factors Affecting Trade Balance

Factors that can affect the balance of trade include:

a)    The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting economy vis-à-vis those in the importing economy;

b)    The cost and availability of raw materials, intermediate goods and other inputs;

c)     Exchange rate movements;

d)    Multilateral, bilateral and unilateral taxes or restrictions on trade;

e)    Non-tariff barriers such as environmental, health or safety standards;

f)     The availability of adequate foreign exchange with which to pay for imports; and

g)    Prices of goods manufactured at home (influenced by the responsiveness of supply)

Why is the Trade Balance Relevant to Forex Traders?

International trade and commerce is all about manufacturing, employment and consumption. Imports and exports attract a demand, and such demand is directly linked to the demand for the local or foreign currencies. This is because a country must use the international currency of exchange when conducting international trade, and the dynamics between imports and exports will dictate on which side of the divide employment will be generated. In addition, consumer spending and consumption habits will be affected by the kind of good imported into a country, or manufactured in a country (either for local consumption or for export). Manufacturing, employment and consumer spending/consumption are factors that greatly affect the state of a nation’s economy, which is why the Trade Balance report is usually one which carries high market impact. The trade balance also has a direct impact on a nation’s GDP.

So how does the Trade Balance report affect the respective countries and their currencies?

a)    Net Importers

Generally speaking, a country which is a net importer (imports > exports) will have to acquire a lot of foreign currency to fund its importation. An increased supply of the local currency + increased demand for the foreign currency will lead to a depreciation of the local currency.

A gross imbalance in the Balance of Trade which tilts towards importation will also take away jobs from the manufacturing sector, and increase unemployment in the manufacturing sector. This factor will also depress the value of the local currency.

b)    Net Exporters

A country which is a net exporter will have more foreign currency chasing its local currency. Export demand will also lead to increased local manufacturing, which creates jobs and boosts consumer spending and consumption. This will cause the value of the local currency to appreciate.

  • So increased deficit (imports > exports) = bad for the local currency.
  • Increased surplus (exports > imports) = good for the local currency

China is a major importer of commodities (raw materials) from Australia, so its trade balance will also have a spill-over effect on the Aussie Dollar (AUD).

Trade Scenarios

What are the possible trade scenarios?

  • Positive trade balance, with actual greater than consensus: Buy local currency
  • Negative trade balance, with actual greater than consensus: Sell local currency

Remember that the greater the deviation, the more the market volatility.

It is important to study the market to see which of the Trade Balance reports are more important to the global economy and to the local economy (with regards to the economic situation). Obviously, a nation which is grappling with unemployment and a bad state of affairs in manufacturing will benefit from a positive trade balance report more than another country where these are not huge concerns.

Do not just blindly buy or sell based on the data. Read the action analysis for each data on sites like Actionforex, and decide whether a Trade Balance report is worth trading. Then interpret the data and trade it accordingly.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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