Inflationary Dollar Shrugs Trade Deficit
The US trade deficit grew 2% in August to $59.03 billion from a revised $57.96 billion (initial $57.94 billion) in July. Imports rose 1.8% to $167.2 bln, while exports rose 1.71% to $108.2 billion.
Notably, the bilateral trade gap grew with all of the US's trading partners with the exception of the Japan where the imbalance fell 1.0% to $6.6 bln. The chart below shows the US bilateral deficit worsened with China (5%), Mexico (+2%), Canada (+11), Eurozone (+2%) and UK (+5%). The change in the trade gap with China was negligible. On a year-to-year basis, the bilateral deficit widened by 17% with China, 47% with the UK, 12% with the Eurozone and 18% with OPEC.
The oil factor was cogently present in the data as imports of crude oil soared 12% to a record $17.2 bln, while imports of petroleum products rose 8% to a record $22.6 billion. As the chart shows below, petroleum imports as a percentage of total impost have more than doubled; from 6% in January 2002 to 13% in August. The increase in petroleum imports accounted for 62% of the increase in total imports, which is the highest since May - when total imports decreased.
The Bureau of Economic Advisors noted the US trade position would be impacted by disruptions in oil and commodity production resulting from Hurricanes Katrina and Rita. On the current account side, the BEA expects an upward impact in the Q3 figure due to a rise in net unilateral current transfers emerging from insurance and reinsurance claims received by donations from abroad for hurricane relief.
Trade Deficit Shadowed by Fed, Dollar Awaits Blockbuster CPI
The dollar's positive reaction in the face of the 2% increase in the trade gap is partly attributed to the fact that the report came in below the psychologically important $60 billion figure many had been expecting due to mounting oil imports. The market is also reluctant to punish the dollar ahead of a flurry of Friday releases-- inflation, industrial production and consumer sentiment. More importantly, tomorrow's CPI release is expected to show a 0.9% increase in the month of January, which would be the highest since January 1990, translating into a year to year rate of 4.3%--the highest since July 1991. Indeed, markets will be scrutinizing the core CPI, which is expected up by a more modest 0.2%--translating into a 2.1% annual rate.
But the dollar may temper any CPI-related gains 45 minutes later when the industrial production figure for September is expected to show a 0.5% decline, the first in 4 months. The Fed estimated that the 0.1% net increase in August occurred in the face of 0.3 percentage point decrease because of disruptions related to hurricane Katrina. The September figure should take into consideration the protracted damage from Katrina as well as Rita.
We saw yesterday that Fed Board Governor Olson reaffirming his position in the Sep FOMC meeting by pointing to the "great uncertainty" of the economic impact of Hurricane Katrina. More importantly, Olson added it was not certain that price pressures are passing through while indicating that rising energy prices could restrain the economy "at least for a time". Since Olson is not subscribing to the rest of the hawkish FOMC members, his stance did prevent the dollar from further extending the gains seen in late NY trade yesterday.
Overall, we stick to our month end forecasts of $1.18 for the EURUSD, 112.00 or USDJPY and $1.7330 for GBPUSD as the markets remains under the spell of the Fed's hawkish rhetoric. We expect the dollar rally to start fading in mid November when markets obtain better visibility as to when the rate hikes will come to an end. Thus, although markets are pricing a 4.5% fed funds rate by end of January, the increased certainty that 4.5% will be the peak should help trigger unwinding - especially as the Bank of Japan sets to remove its accommodation in Q1 and the ECB to maintain its inflationary red flags.