Trade balances are evaluations of the relationship between the imports and exports of a given country. Particularly, the purpose of the trade balance is to determine if the amount of goods and services leaving the country is reasonably balancing in good levels with goods and services being imported into the country. Properly assessing the current balance of trade for a given country provides key information about the overall economic health of the nation.

Why is it important?

Since this report has, a drawback in terms of its release timing, it is monitored in conjunction with a variety of other economic indicators to help gauge the direction and strength of the foreign trade. Although it is not as timely as other monthly economic indicators as its data is released approximately six weeks after the reference month, its importance may be overshadowed in the face of fresher economic data. That is released on a monthly basis. It however directs the strength of the forex rates of the dollar in a big way.

How is it computed?

The most common method of computing the current trade balance is by picking a specific period to consider, preferably a gap of between three to six months. Although a complete calendar year can be taken for consideration. On establishing the period, figures relating to the total amount of imported goods and services for the cited-period are compiled. After determining the cost of goods and services that entered the country during the particular period, the next step is to identify the cost of goods and services exported to other countries within the same period. The total cost of imports is then subtracted from the total cost of exports in order to determine the current trade balance. Two prominent terms are then used to describe the results. If the exports exceed the imports, it is considered a trade surplus and when the imports exceed the exports then it is termed a trade deficit. A trade surplus will indicate growth of the economy while a trade deficit is a likely indicator of a troubled economy.

How does it affect forex trading?

International trade in goods and services is the only tangible way through which a country can earn foreign exchange. To have a strong forex rate, the amount of exports should exceed imports. This would mean that the country in question generated more revenue that stayed in the country than what went out to other countries. More exports than imports will translate to a relatively healthy trade balance and most likely lead to a stable economy. On the contrary, if imports exceed exports, more revenue is leaving the country than is coming in. This can lead to a deficit in forex earnings, a situation that would lead to a weaker exchange rate as the country‘s central bank would be forced to buy foreign currencies at higher rates to meet the demand leading to the decline in the exchange rates of the local currency. These circumstances may simply imply that the amount of local production of goods meant for export has drastically dropped and the country has become a market for other countries to come and sell their products at the expense of our local industry. This situation should be swiftly addressed as it may affect even the country’s GDP thus reducing the population’s purchasing power due to increased unemployment.
Changes in the imports and exports levels, along with the difference between the two forms a major benchmark for gauging economic trends locally as well as abroad. The data directly affects all the financial markets, particularly the foreign exchange value of the dollar. High imports indicate an increase in demand for foreign goods and services locally while high exports show the demand for U.S. goods abroad. Such changes in the chronic trade deficit run by the United States can greatly affect the dollar since this trade imbalance creates greater demand for foreign currencies. The bond market is also sensitive to such and therefore the policy makers should try to check the trends or risk importing inflation into the economy.

How does it affect the stock market?

Monetary policies and the perceived direction of the economy play a major role in determining the direction of stock prices. If the trend in the trade deficit narrows in a way that suggests that net-export growth is overheating, bond prices could fall on the outlook for greater overall economic output of goods and services. If investors perceive a potentially higher inflation amid increased chances that the Federal Reserve may hike interest rates, the effect would be a sudden drop in Stock prices as investors seek to release their holdings into the market sooner that the Fed can take any measures that may affect their shares. In the same spirit, a rise in bond yields can eventually make bonds more attractive once the fall in bond prices settles down. Although corporate profit growth may be supported during the period of strong net-export growth, the market will likely see it as short-lived given that expectations for impending rate hikes and eventually slower economic growth will be their greatest perception. Such moves may deflate the values of shares very dramatically
On the other hand if there is a trade surplus; meaning that the exports have exceeded imports and the economy is registering strength and the trend indicates consistency along these lines, the stock shares would take an upward surge as most investors would be reading better economic times ahead. They would therefore want to buy more shares or jealously guard their existing holdings thus reducing the availability of shares for sale. This pattern would mean that the few who are willing to sale would have the privilege of asking for higher prices for their holdings. It is simply a game of perceptions and speculations and the principles of demand versus supply will always prevail during such times.