width=178Release: China Trade Balance (Jan) Consensus Forecast: $10.1B Previous: $16.5 Date/Time: 02/09/12 8:30PM ET (01:30 GMT, 02/10)
China's Trade Balance Still A Key Gauge for Global Trade

As we head towards the end of the week we continue to see general risk sentiment positive as our most basic measure of sentiment - the S&P 500 futures - continues to push towards fresh highs multi-month highs.

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The rally in the S&P 500 over the last month and a half has been based on the stabilization in the European banking and sovereign markets as a result of actions taken by the ECB, generally positive macro data from the US, and some better-than-expected earnings from US companies.

As a result big key question is whether these gains can continue considering the rally has, on fairly thin volume.

The considerations for whether we will have a continuation to the risk asset rally is likely to come from a combination of expectations around more provisions of liquidity by central banks but also a renewed focus on macro data including key releases like China's trade balance.

China's trade levels are a key gauge for global demand. Stronger exports from China implies that foreign demand in key markets continues to be robust and would further the case that's they cut global economy after suffering a setback in the fourth quarter is rebounding to begin 2012. Higher imports in the trade balance report would imply that Chinese consumers and companies are confident enough to buy foreign goods and/or materials and would imply a stronger growth rates for the Chinese domestic economy.

Slowdown in Export and Import Growth Expected, Lower Trade Surplus as a Result

However, as you come into the report expectation is for the opposite - mainly a slowdown in both export and import growth and thereby a decline in the trade surplus for China.

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China's trade surplus  is expected to drop by around 1/3rd to $10.7 billion in January from $16.3 billion in December. That would make it the weakest surplus in in 10 months.

Exports are expected to decline 1.5% year-over-year in January compared to 13.4% rise in December, while imports are expected to drop 5.0% year-over-year, compared to an 11.8% increase in January.

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These figures certainly imply softer global trade and a weaker global economy, which can drag on equities and commodity prices and put pressure on growth and commodity linked currencies like the AUD and NZD.

Weaker year-over-year export growth has been a trend in China as one can see from the chart below.

While exports have generally continue to rise, the general trend has been for a slowdown in annual change, and now the expectation is for January to turn negative. That could surely raise the concern of Chinese authorities.

Below, you can find a comparison of exports and imports going back to the beginning of 2007 see can see that change in growth in both categories yourself (click on the image for a larger image).

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Trading the Report & its Implications for PBOC Policy

Yesterday we previewed the Chinese CPI data and asked about the missing reserve ratio requirement (RRR) cut that was expected in January. Weak trade data could give the People Bank of China more impetus to go through with the RRR, though the CPI data made that less likely with a jump in inflation to 4.5% y/y in January from 4.1% in December.

The upcoming trade data therefore can give us more clues or direction as to the intent of the PBOC, which makes this report a little bit tricker to assess.

A weak trade report usually would be a risk negative fundamental event risk, meaning that safe haven currencies (USD, JPY) would gain on higher yielders tied to global growth (AUD, NZD, CAD). However, if a weak trade report increases the chances of looser monetary policy by the central bank that could help boost Chinese equities and give the Asian session a risk on bent.

A strong report would therefore also create 2 opposing forces. First, it would imply better than expected global demand for China's goods, meaning the global economy is stronger than expected. Usually that is met with a risk-on reponse benefiting equities and higher yielders. However, if such a report is see to delay any cuts of the RRR by China's central bank it could weight on sentiment.

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The consensus forecast, with its expectation of soft exports and imports favors the first case.

How Chinese equities respond will be a leading indication for the rest of Asian equity markets and therefore for currency markets.

As we can see, the Shanghai index is trying to break a persistent downtrend begun in the 1st half of 2011. Speculation of looser monetary policy as well as a rise in global equities have helped this rebound. Chinese authorities are keen to not repeat the mistakes of 2008 when they loosened policy too fast and set up a battle with inflation, but some move in that direction would certainly help sentiment.

Therefore, a weak trade report may be seen as the better scenario for Chinese equities as it means a looser central bank. However, a positive surprise in terms of exports, can also help to fuel gains, perhaps making this report a win-win for a Chinese investors.

Can it also be a win-win for those currencies (like the AUD and NZD) that respond positively to better global trade or looser Chinese policy? Perhaps, but a weak report showing a drop in China's exports and imports can also be a catalyst for a pull back from risk amid concerns global growth is stalling.

For a technical analysis look at the AUD/USD, see today's technical update: AUD/USD - A Counter-trend Trade Plan As Bull Market Stalls

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Nick Nasad is an analyst, educator, and trader; and one of the main contributors to  FXTimes - provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.