How Global Trade and the Value of the Dollar Impact Mortgage Rates

Trade Balance data is out....

Trade balance data reports the difference between the monetary value of a country's exports and imports. A positive balance, or trade surplus, means exports exceed imports and illustrates that a country's economy is globally competitive.A negative balance of trade is known as a trade deficit or trade gap.

The trade deficit narrowed considerably more than expected in October as exports increased 3.2% and imports decreased by 0.5%.

Here is the Reuters Quick Recap.....

RTRS-US OCT TRADE DEFICIT $38.71 BLN (CONSENSUS $43.60 BLN) VS SEPT DEFICIT $44.60 BLN (PREV $44.00 BLN)

RTRS-US OCT EXPORTS +3.2 PCT VS SEPT +0.5 PCT, IMPORTS -0.5 PCT VS SEPT -0.7 PCT

RTRS-US OCT GOODS DEFICIT $51.42 BLN, SERVICES SURPLUS $12.70 BLN

RTRS-US OCT EXPORTS $158.72 BLN VS SEPT $153.78 BLN, IMPORTS $197.44 BLN VS SEPT $198.37 BLN

RTRS-U.S. OCT CAPITAL GOODS IMPORTS $39.01 BLN VS SEPT IMPORTS $39.92 BLN

RTRS-U.S.-CHINA OCT TRADE DEFICIT $25.52 BLN VS SEPT DEFICIT $27.83 BLN

RTRS-US-OPEC OCT TRADE DEFICIT $5.69 BLN VS SEPT DEFICIT $8.88 BLN

RTRS-US OCT OIL IMPORT PRICE $74.18/BBL VS SEPT $72.36/BBL, +10.1 PCT FROM OCT'09 $67.37/BBL

RTRS-US OCT TRADE DEFICIT NARROWEST SINCE JAN 2010, TOTAL EXPORTS HIGHEST SINCE AUG 2008

From the release...

Total October exports of $158.7 billion and imports of $197.4 billion resulted in a goods and services deficit of $38.7 billion, down from $44.6 billion in September, revised. October exports were $4.9 billion more than September exports of $153.8 billion. October imports were $0.9 billion less than September imports of $198.4 billion.

The September to October increase in exports of goods reflected increases in industrial supplies and materials ($2.6 billion); foods, feeds, and beverages ($0.7 billion); automotive vehicles, parts, and engines ($0.4 billion); capital goods ($0.4 billion); other goods ($0.1 billion); and consumer goods ($0.1 billion).

The September to October decrease in imports of goods reflected decreases in industrial supplies and materials ($1.7 billion); capital goods ($0.9 billion); and foods, feeds, and beverages ($0.1 billion). Increases occurred in consumer goods ($1.3 billion) and other goods ($0.3 billion). Automotive vehicles, parts, and engines were virtually unchanged.

Services exports increased $0.4 billion from September to October. The increase was mostly accounted for by increases in other private services (which includes items such as business, professional, and technical services, insurance services, and financial services), travel, and other transportation (which includes freight and port services). A decrease in transfers under U.S. military sales contracts was partly offsetting. Changes in the other categories of services exports were small.

Services imports increased $0.2 billion from September to October. The increase was more than accounted for by increases in other private services, travel, and passenger fares. A decrease in other transportation was partly offsetting. 

Wow. Check out that 29.8% increase in exports to China. That's funny. We're exporting raw materials to China and they're sending us back a finished product. Not this month though! Imports from China decline by 0.5%. Brazil sent us a bunch of stuff though....

I've been harping on the major mismatch between the labor skills supplied by America and the labor skills demanded by American companies for some time now. More specifically I've been belly achin about non-specialized blue collar workers losing their jobs to investments in productivity (technology/robots/automation), not to mention overseas goods producers like CHINA who pay their work force a helluva a lot less than we pay our work force. 

This has to change if our economic recovery is to gain any traction. We cannot afford to keep stimulating consumer spending through socialized entitlements like unemployment benefits (although we have to extend them right now). QEII is not printing money if banks are not lending, but we sure as hell are printing money through weekly unemployment benefits. If we want to put our non-specialized work force back on payrolls, we need to see the Trade Balance level out a bit. A weak dollar helps do that........

If we are exporting more goods and services, we will create more jobs for Americans because U.S. companies must increase production to satisfy new (or rejuvenated) sources of demand from  both domestic and foreign consumers. Greater production translates into faster growth of local economies and a stronger consumer balance sheet, ultimately leading to increased consumer spending.

Trade balance data is generally dependent on two factors: US economic growth rates relative to other countries, and the value of the dollar as changes in the value of currency can alter the relative price of goods.

A strong dollar is a negative for the trade balance because it lowers the price of imports for American consumers. This domestic demand buys foreign goods because of relatively cheaper costs. At the same time, a strong dollar is bad for US companies as it raises the price of US goods for foreign buyers. This encourages foreign demand to search for a lower price in another country.

A weak US dollar makes imports more expensive, forcing Americans to buy goods and services from domestic suppliers. The weaker dollar also gives foreign demand the opportunity to purchase American made goods at a lower price, thus increasing demand for US goods and services.

Market Reaction...

Bonds sold off on the news.  The 2s/10s curve is 6bps steeper at 265bps wide. The 5yr note is -2/32 at 97-15 yielding 1.914%. The 10yr note is -14/32 at 94-19 yielding 3.265%. The FNCL 4.5 is -5/32 at 102-10. Loan pricing will be worse this morning.

Why did bonds sell off on the news?

Well. First and foremost I am not saying this news is a fundamental "game changer" in terms of the economic outlook. We're still dealing with year-end trading motivations and a lack of liquidity. But if I had to rationalize I would say...

The value of the dollar declined over 14% from its June 7 high through to the end of October and held there all the way into the QEII FOMC announcement. So it isn't super surprising to see an improvement in U.S. exports as the dollar weakened and made our goods cheaper to our global trade partners...but the jump was still much larger than expected so we have to raise a skeptical eyebrow. Unfortunately we are left to wonder if the improvements will last as the value dollar improved vs. the rest of the world in November.

Fundamentally, because the firmer Trade Balance was largely a factor of increases in exports of industrial supplies and materials ($2.6 billion), a bond trader might consider this a big plus for the labor market outlook (specifically the non-specialized group). Remember, we did see a large improvement in payroll numbers and jobless claims as the dollar weakened and U.S. exports in October. This is one of Ben's indirect goals with QEII. Weaker dollar = more exports = more U.S. jobs. But the dollar weakened all the way into the QEII announcement and then reversed course afterward. Will job creation continue if the dollar continues to strengthen and U.S. goods and services get more expensive from a foreigners perspective? Again..the skeptical eyebrow is raised. But clearly you can see the impact that QEII had on the dollar and on job creation.

Plain and Simple: QEII frontrunning weakened the dollar and cheapened U.S. made goods and services for overseas buyers in October. This helped increase demand for our products which improved domestic labor market conditions. Will the labor market continue to recover if the dollar rally extends? Stronger dollar = weaker U.S. labor market = better for bonds?  Weak doller = strong U.S. labor market = worse for bonds? See why globalization is such a big dea?