Forex trade balance?
The trade balance is an important economic indicator, let’s find out more about it.
It’s a sub-account of the current account which is both a part of National Accounts, and a tier 1 Forex economic indicator in its own right.
Awesome but what does the account/indicator measure?
Exports of goods and services – Imports of goods and services
Why is this important?
In many economies, the forex trade balance (or just trade balance) represents the majority of currency transactions taking place.
You’re in country A, and I’m in country B.
I grow avocados and sell them to you (an export from B to A).
This transaction constitutes international trade because it involves at least two countries.
The avocados represent an export for country B.
And at the same time, they represent an import for country A.
My exports are your imports.
This is why the global trade balance is roughly a net 0 (global exports should equal global imports).
Thy are not exactly 0 because there are some negligible measurement errors (in practice, accounting appropriately for every single international transaction of goods and services is hard!).
Ok, but what does this have to do with forex?
I only sell avocados in $B$, the currency of country B.
But being from country A, you deal in currency $A$, the currency of your country.
In order to buy the avocados, you had to buy enough $B for me to trade them to you.
How did you buy the required $B$?
You went to a bank, or fx broker to buy them in exchange for your $A$ currency.
And as you well know, the amount of $A$ you had to exchange for $B$ is given by the exchange rate between the two currencies.
See where we’re getting at?
If the exchange rate between currencies is determined by supply and demand, then the trade balance has great impact on exchange rates (as do other transfers, and capital flows captured on the current account).
If the only transaction that occurs between countries A and B are avocados.
And all of these transactions are one-way (B exports to A), then the currency of B will always be in higher demand than the currency of A.
Everyone is selling their $A$s in exchange for $B$s (they must really like avocados).
Therefore, $B$/$A$ should appreciate when exports of avocados move up.
And depreciate when exports move down (fewer $B$s being bought by $A$s).
Of course, these results are valid under the favorite assumption of economists: all else being equal (supply of the currencies, for example).
As always, the importance of forex trade balance, as well as other tier 1 indicators is how much attention a Central Bank, and the markets are paying to it.
I’m starting to sound like a broken record, but it’s worth repeating:
Don’t trade into a pair just because trade balance numbers were “good” and the currency in question should appreciate.
That’s robotic nonsense.
And it will liquidate your account.
Do pay attention and trade it if the markets are perceiving it to be important at the time in question.
How do you know if it’s important at that moment?
Read Fx newsfeeds, news sites, and what not.
If you see the event in question being discussed in multiple sources (ahead of its release), then it’s likely it’ll have some relevance.
However, even that is not sufficient.
You need to think by yourself:
Does the Central Bank care about this data for its rate decision (as in, this data might AFFECT the decision)?
If the answer is maybe, then it’s not good enough.
If the answer is YES, then you definitely need to pay attention, and trade the sh$t out of the event.
If the forex trade balance is part of the current account, why do we care about both, separately?
Good question, remember that at any point in time, a Central Bank might be more interested in one specific aspect of the economy, thus, it might care about trade specifically, and not the whole currency balance (current account).
At other times, the reverse might be true.
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