China 8217 s trade deficit may be more than seasonal

The alarming decline in China’s February trade figures–showing the biggest percentage drop in exports in 4.5 years and the biggest trade deficit in 2 years ($US23 billion)—may be alleviated by the seasonal reality that China’s trade balance has consistently reached a cycle low in either February or March in each of the last nine years.

The chart below highlights that each cycle bottom in China’s trade balance coincided with either February or March. The last four cycle lows in the trade balance (whether a low surplus or a high deficit in the cycle) occurred in February 2014, 2013, 2012 and 2011, preceded by March 2010, February 2009 & 2008, March 2007 and February 2006.

Yuan decline & Lunar year

China’s Customs Administration attributed the trade deficit to the Chinese New Year as companies typically front-loaded their exports before the holiday. The yuan’s 1.4% decline vs USD in February (biggest monthly drop since May 2012) was also influential in weighing on exports and boosting imports.

Currency: Cause not effect

Rather than attributing the weakness in the trade figures to the currency decline, it is more accurate to view the latter as an effect of the general slowdown in the economy and authorities’ concerns with speculative carry trades.

CNY’s weakness reflects recent efforts from the People’s Bank of China to encourage 2-way volatility ahead of next month’s National People’s Congress and affirm that the currency is not a one-way bet. A more natural flow in the currency would be required to liberalize the capital account and shore up foreign bank trading participation. Despite calls from the West, the PBOC had already resorted to managed currency weakness in the past in order to dampen speculative activity and excessive capital inflows.

But it is not all the authorities’ fault. The fall in China’s bond yields is starting to push investors out of the CNY-carry trade (borrowing cheap USD financing to import goods such as copper, which are later exported for CNY and depositing the proceeds at higher yielding CNY-denominated bank account) especially as the prolonged slowdown in China’s economy is further complicating the solvency of trust credit products tied to the mining industry, and thereby impacting the credit chain.

Wholesale deflation

China’s macro weakness is increasingly highlighted on the wholesale level. The latest PPI figures showed a 2.0% drop in February y/y, which is the 23^rd consecutive monthly decline and the longest periods of whole sale price contraction since the 1990s.  Should US bond yields extend their upward push past the 3.0% level over the medium term and the PBOC maintains a lid on local yields as well as the currency, then the unwinding of the USD-CNY carry trade could start showing facets of the imploded USD carry trades vs South East Asian currencies in 1997-98.

Beijing’s ability to bailout and contain liquidity thanks to its $3.8 trillion in currency reserves remains key in preventing a repeat of Asian currency crisis.  Yet, the magnitude of the yuan’s decline is a major factor in raising warnings that February’s weak trade figures reflect more than seasonal factors as Beijing drove down the yuan’s daily reference rate against the USD rate to 3-month lows. In February, the USD/CNY daily reference rate fell in three of four weeks, the most since August 2012.