We were going to update the chart (and the saga) of the weakening U.S. dollar today anyway, but after yesterday's big news, this chart became even more meaningful. If you didn't hear, the trade deficit fell to a six-month low in March. The Commerce Department reported that the gap between imports and exports fell to $54.99 billion, which is another way of saying that there was a net outflow of U.S. dollars in March, to the tune of the same 55 billion. That dip is a 9 percent decrease from February's record gap of $60.57 billion, which of course, investors liked to hear. The question is, is that a reason to get bullish? It all depends on your prespective. Ironically, the stimulus that caused the gap to be closed may well be a thing of the past.

The reaction to the news was understandable. Investors heard the words "deficit gap narrowed" and got excited, possibly without really thinking things through completely. Is this really good news? And if so, what should traders and investors do with it?

To answer the first question, yes, this is generally good news as far as the domestic U.S. is concerned. Rather than seeing dollars get sent overseas, they're being kept (spend and invested) here. That ultimately means that U.S. consumers are buying U.S. goods, which benefits U.S. manufacturers and service providers. It also means that some more of our goods and services are being bought by other countries, which again should benefit domestic companies.  

But, it all has to be kept in perspective.

First, this data is two months old (from March). Has this information already been priced into the U.S. stock market? Odds are that it has, leaving no real room for additional gains. Second, this 9 percent dip in the deficit follows the all-time high deficit from February. Of course we're probably going to see a dip - a brief reversal is a common occurrence when you hit new levels. In other words, we really had nowhere to go but down. The longer-term deficit trend is far more meaningful, and the trend itself is still a bit questionable. The forecasted deficit for this year (based on the trend over the first quarter) is still going to be bigger than last year's annual deficit, which happened to be an all-time high as well. So while this may indeed be the beginning of a lot of trade problems being resolved, we're still not seeing nearly enough evidence of that to say that the worst is over. In fact, the improvement in March was largely the result of slowed imports of Chinese textiles. It's not likely that we have any more lucky breaks like that in the pipeline.

In fact, our chart of the U.S. dollar suggests the opposite. Based on the potential rebound in the dollar (compared to euros and yen), there's probably going to be more pressure for the trade gap to be widened rather than closed.

This is the same chart of the euro/dollar conversion rate that we've been plotting for weeks. It's moving higher as the dollar has weakened because it's comparing the euro to the dollar (or the euro/dollar exchange rate). The dollar started to weaken in 2002, and the euro started to turn higher for what would end up being a three year rally. This chart had an obvious support line (red), and the 200 day line (green) would also come into play on a limited basis. But over the last few weeks, and to a great extent on Wednesday, we're seeing a lot of pressure on the euro in relation to the dollar. or in other words, the dollar is looking like it's getting stronger again. As we mentioned the last time we created this chart, though, there's not yet enough evidence to comfortably say the dollar is on the road to recovery. The clincher will be a close under 1.273 (dashed line). That would represent a lower significant low, and it would be the first time we've seen it in years. We're close to that now, and given that we're already under the support line, taking that next step wouldn't be a giant leap.

Euro/Dollar Exchange Rate - Weekly

So what's the dollar got to do with one's perspective on a shrinking trade deficit? Everything, which is why we want discuss both of them simultaneously!

Aside from the Chinese textile import reduction, our net deficit may finally be shrinking because of the weak dollar. See, a weak dollar makes foreign goods and services (from a U.S. perspective) expensive, so domestically produced goods and services are in demand. Thus, imports decrease. At the same time, a weak dollar means other countries have a lot of buying power when it comes to things priced in dollars. So, there's an increase in demand for U.S. exports. Both of these situations are good for American companies. It took three years and a rock-bottom dollar to get here, but maybe.....just maybe....the dollar is finally "weak enough." One month does not set a trend - especially one that's been in place for a few years. So, we'll have to wait and see if the weak dollar has finally done what it's "supposed to do."

Eventually though, one side of the equation will have to give, if it hasn't already. If the dollar stays weak or gets even weaker, there will be pressure on the gap to close. If instead the dollar strengthens, the gap will be widened. Ideally, a balance would be achieved so that wouldn't have to be the scenario, but that's near impossible when facing all the other forces at work here.

And the point of all this? Here we go: If the dollar does indeed rebound, as we think it will, then don't look for the trade gap to continue shrinking. In fact, it could be quite the opposite. So any rally based on the trade deficit news yesterday may have been premature. Besides, it was just one month's worth of data following an all-time record high deficit. Be sure to keep it all in perspective.

And on a side note, regardless of what happens with the dollar and the deficit, you can still maximize your returns by thinking about who benefits from each scenario. A weak dollar is great for U.S. companies, while a strong dollar is great for foreign companies with American customers. And just because the trade deficit is growing doesn't mean that plenty of stocks can't go higher. At the same time, don't assume a shrinking deficit is widely bullish for American stocks, because it may not always be. As we said before, perspective is everything.

Price Headley is the founder and chief analyst of BigTrends.com.