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UBS: "One Of The Most Surprising Charts Of The Year Got Slightly Less Surprising"

Having emerged as one of the most macro saavy UBS strategists, Arend Kapteyn - who several months ago first highlighted the unprecedented crash in China's credit impulse - points out something he first highlighted several months ago: a "surprising" paradox in which despite "signs of economic strength" across the developed markets, these same markets had yet to register any pick up in imports, or as Kapteyn puts it, "one of the most surprising charts of the year, for us at least, has been the one below: despite the strength of growth in the Eurozone, Japan and other parts of DM, there had literally been zero pick up in aggregate DM import volume growth through April."

In fact, he continues, "it appeared as if the entire global trade volume recovery was being driven by emerging markets. And a good chunk of that was China, where the collapse in the credit impulse and the property market slowdown is already leading to less importintensive growth (i.e. some rotation away from investment to consumption). That's a big problem if you're a reflationary optimist: perhaps the most important 'hard' data point that seemed to be confirming the strength in the 'soft' surveys looked to be built on very thin ice."

That changed this week, when UBS received the latest, May data.

According to CPB's Global Trade Monitor released Tuesday, DM import demand jumped higher in May (2.98%MoM) — the largest monthly jump since May 2010—and corrected somewhat the earlier weakness. There is still a large EM/DM gap but now less extreme, largely thanks to an improvement in the Eurozone import data. There was a similarly large gap back in 2013 but that was in the midst of the Eurozone crisis, when DM faced a massive negative fiscal impulse, and before EM growth had been dragged down by a negative terms of trade shock.

The problem, however, is that as UBS writes, the global trade recovery is right at the point where export deflators are turning from tailwinds to headwinds: "that effect should dominate the volume rotation from EM to DM and we expect nominal trade (values) to lose momentum in H2-2017."

So what happens next, and why if the DM import volume demand is finally improving (with some rotation from EM to DM), is UBS "still gloomy about the global trade outlook?" Here is the explanation:

Largely because the bulk of improvement in EM exports since the -15%YoY trough (in August 2015) was being driven by a diminished drag from export deflators, not volumes (figure 8 & 9), and those deflators are going to turn into headwinds.



Figure 4 shows how a simple model of global commodity prices (CRB Metals index, CRB food index, and Brent oil) and the USD NEER can explain 83% of the variation in the global export price deflator.



Figure 5 shows the breakdown by component: two thirds of the 2014-2016 trade weakness was simply a USD effect and the other one third a simultaneous decline in food, metals and oil prices. As those drags diminished we had a large nominal recovery but unless we see materially more USD weakness or commodity price strength the deflators will ultimately converge back to zero. We estimate that we are already past 'peak export deflator support' (our model suggest an imminent 6% drop in global export prices), though we should get a last gasp deflator recovery again later this year thanks to food price and USD base effects.


After that, ceteris paribus, global trade growth should fall back to mid-single digit range, unless we finally see the DM import demand recovery becoming more broad-based and more investment intensive.