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Trade roller coaster

admin | January 10, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Net exports is generally one of the most volatile components of real GDP, as exports and imports often swing wildly from one month to the next. On top of the normal volatility, firms have recently responded to on-again, off-again tariffs and threats of tariffs by adjusting the timing of shipments, making the net exports component even more unpredictable. The signing of a Phase One trade deal would commit the U.S. to scale back tariffs, and put a moratorium on new tariffs, while China would commit to large and presumably steady purchases of U.S. goods. While this could reduce the volatility of net exports in 2020, trade still looms as one of the most important factors for Q4 2019 GDP.

Steady deterioration in the trade balance

Through much of the current expansion, the U.S. economy has fared better than those of many of our trading partners. U.S. imports have generally grown faster than exports and the trade gap in real terms has widened, even as the petroleum deficit has disappeared. In fact, net exports in real terms were a drag on growth for five straight years through 2018 (see Exhibit 1), subtracting close to half a percent on average per year from real GDP growth.

Exhibit 1: Net exports contribution to real GDP growth

Note: Data is quoted on a Q4-to-Q4 basis. Source: BEA

Tariffs and trade negotiations

A complication was added to the trade picture beginning in 2018, as a series of tariffs were put in place on a subset of the goods traded between the U.S. and China. In most cases, the mechanics of imposing tariffs required President Trump or a representative of the Administration to announce any new tariffs well in advance of when they would go into effect, both to satisfy regulatory rules and to avoid a situation where the tariffs on goods on a freighter bound for the U.S. were thought to be at one level when the ship left the port and found to be at another level when it arrived at its destination, effectively a retroactive move.

The delay from announcement to imposition of tariffs allowed shippers to manipulate the timing of trade flows.  This dynamic began in the spring of 2018, when U.S. firms, especially those involved in the export of agricultural goods, rushed exports to China in anticipation of retaliatory tariffs that were speculated to be on their way.  Real exports surged by 5.8% on an annualized basis, leading to a narrowing of the trade gap, adding 0.8 percentage points to Q2 2018 real GDP growth.  In the third quarter, the reverse occurred, as exports plunged, partly because China halted purchases of U.S. soybeans, but imports surged, as importers tried to rush in goods from China before the imposition of tariffs (tariffs that ultimately took effect in late August).  As a result, the trade gap exploded by over $100 billion in Q3 2018, subtracting two full percentage points from real GDP growth. The trade balance deteriorated further in Q4, when importers continued to speed shipments into the U.S. with a threat looming of a new round of tariffs on January 1, 2019.

That tranche of threatened tariffs was subsequently delayed to March and eventually postponed again when it looked in early 2019 like a comprehensive deal was within reach. U.S. imports retreated, while exports strengthened, due to renewed Chinese buying of soybeans.  As a result, trade added 0.8 percentage points to real GDP growth in Q1 of 2019.

Then, the tone of negotiations turned sour in May, leading to a series of tariff threats from the U.S. and retaliation from China.  Soybean shipments from the U.S. to China were halted again in Q2, contributing to a steep drop in exports and a 0.6 percentage point drag to real GDP growth in the quarter. The trade gap in real terms rose to an all-time high in Q3, as imports of consumer goods to the U.S. surged in July and August ahead of a new round of tariffs announced in July and imposed in September.

Q4 surprise

One would have thought that imports would have continued to rise in Q4, as yet another new round of tariffs was announced with a December 15 effective date. However, retailers had the bulk of their peak Christmas shipping orders done earlier in the year. Consumer goods imports collapsed in September, October, and November, falling to a three-year low.  As a result, the data through November point to a massive narrowing of the trade gap in real terms, perhaps adding 1½ percentage points to real GDP growth in the period (see Exhibit 2).

Exhibit 2: Net exports contribution to real GDP growth

Source: BEA.

Smooth(er) sailing ahead?

With a Phase One trade deal finalized, the U.S. has reduced tariffs and, more importantly for this discussion, reportedly promised not to raise tariffs again as long as China is abiding by the terms of the deal. China has committed to buying large amounts of U.S. goods, which is likely to require heavy and steady purchases, including for soybeans and other items that were used as leverage in the trade negotiations over the past two years.  As a result, the on-again, off-again trade flows that produced such large swings in the quarterly GDP figures (trade either added or subtracted at least half a percentage point to/from overall real GDP growth in five of the seven quarters in question) may give way to steadier trade numbers in 2020.  While there will likely still be considerable quarter-to-quarter gyrations going forward, they should be smaller than before and presumably less predictable.  The real trade deficit should widen noticeably in Q1 of 2020, unwinding some of the Q4 lurch, and then settle into a quieter pattern within the context of a gradually widening deficit over time.