Trade Insight April 2015

Currency volatility on the rise | EUR-USD heads for parity while equities climb


Executive Summary


Delta Economics’ Trade Corridor Index Assets (TCI-A) analysis for April suggests the following:

  • There will be continued optimism about European recovery in particular as the Purchasing Managers’ Indices rise.
  • The optimism in European growth will not boost the value of the euro. Quantitative Easing (QE) is already putting downward pressure on the euro which, combined with the political and financial consequences of Greece’s debt repayments, is pushing the value of the euro down further versus the US dollar.
  • As a result, the TCI-A is suggesting short positions on EURUSD. We expect the bearish trend to continue through the month and although there could be some resistance around €1.05:$1 in the middle of the month, the model suggests it could go as low as $1.01 by the end of the month with parity likely during May.
  • Meanwhile, we are bullish on the Dax and Eurostox 50, which are attracting capital inflows as a result of QE.
  • In the run-up to the general election in the UK we are expecting the value of sterling to fall against the US dollar. If Industrial Production results in the UK are weak, then we expect this to increase volatility in the value of sterling. This volatility is likely to continue as the general election nears as investors weigh up the business consequences of a Labour government versus the uncertainties of a referendum on European membership with a Conservative government.
  • The long positions we are taking on Asian equities reflect the fact that QE in Europe has increased capital availability and weakened the value of the euro.


Outlook for PMIs April 2015


The Trade Corridor Indices (TCIs) measure the trade flows of any one country and forecasts these forward using its proprietorial forecasting methodology. Each index is specific to the country it relates to in that the trade corridors and flows will differ for each country. The rate of change in the index is correlated with the Purchasing Managers’ Index (PMI) for that country.

The TCIs are based on actual data and although they are highly correlated are in no sense an alternative to the PMIs since the methodologies differ. PMIs, being survey-based, are sentiment indicators while the TCIs give an actual and a forecast indication of how underlying trade conditions, including trade finance, are moving. In other words, the TCIs provide a predictable and quantifiable view of how changes in the global economy are affecting trade at an individual country level. They are constructed as follows:

  • The correlation of a country’s top 500 trade corridors with that country’s Manufacturing PMI to create a trade corridor index associated with the PMIs/sentiment (TCI-S).
  • Correlation of the rate of change in that index (six-month moving average) with the Manufacturing PMI.
  • The monthly change in the six-month moving average (positive change suggests PMIs will improve while negative suggests they will deteriorate).

The full PMIs are expected to move generally in line with the Flash PMIs and consensus in April 2015. Overall, only very small movements in the PMIs are predicted, either by us or by the market. The PMI data has ceased to move markets substantially and the very similar results each month suggest that there will be little market volatility around these indicators this month.


Key points:

  • We are generally optimistic and in line with consensus about Europe’s PMIs. We are substantially more positive about French services than consensus, but the correlation is low so there is a high downside risk on this.
  • We are expecting a mild increase in the US Manufacturing PMI while consensus is predicting a mild downturn. However, the spread is very small between the two and, as this is an estimation of a survey, this could be within an error margin.Trade Corridor Index Asset Price Calls



Figure 1 | PMI Outlook, April 2015
Source | Delta Economics analysis


Trade Corridor Index Asset Price Calls



The Delta Economics TCI-based asset management strategy takes the top 500 trade corridors (trade between two countries by sector) against an asset price. It creates an optimum corridor index of those trade corridors each month and has been tracking its performance over the past 21 months. This is a systematic model and assets are included in the portfolio if one of the following conditions is met:

  • The signal strength (which measures the percentage of trade corridors that are pointing to a long or short call) must be higher than 95%.
  • The signal strength is greater than 85% and the Information Ratio (which measures the performance of that optimum corridor relative to benchmark returns) is greater than 0.5, indicating good or very good back-tested performance.
  • Where there is a signal strength of 100 and only one corridor in the index, the Information Ratio must be above 0.5.

The returns across the portfolio reflect the accuracy of the calls only. They are not optimised in any way, do not include transaction costs and are based on an equally-weighted portfolio across the asset calls that conform to the conditions above. There is no leveraging.

Key point | In March 2015 these paper returns were 1.9% suggesting that over the past 21 months, we have called the assets in a way that potentially produces an above-market performance of 1.4% per month.




Figure 2 | Monthly Returns of TCI-A strategy (%) June 2013 – April 2015
Source | Delta Economics analysis


We are calling metals long this month but our signal strengths and Information Ratios have deteriorated since February. This reflects continuing volatility in commodity prices; the price of oil, for example, is being influenced by uncertainties in the Middle East which, if they continue, could put strong upward pressure on prices.




Figure 3 | Delta Economics TCI-A Based Strategy, Commodity Calls for April 2015
Source | Delta Economics analysis



QE in Europe and Japan alongside continuing uncertainty around any rate rise means that equity markets are likely to continue their bull run. Information Ratios continue to be weak suggesting that there is real volatility in the market, while the signal strengths on global (European and US) equities are much stronger than they are on EM equities. This is a product of capital movements into Europe post QE and continuing concerns about the depth of any Chinese slowdown. Of the Asia-Pacific markets the ASX 200 and BSE look to be the strongest performers in April.




Figure 4 | Delta Economics TCI-A Based Strategy, Equity Calls for April 2015
Source | Delta Economics



We return to a bearish stance on the euro versus USD for April and overall our calls suggest that the strength of the US dollar versus most currencies is likely to continue. The only exception is our bullish stance on the AUD which is based on a reasonable signal strength and strong Information Ratio.




Figure 5 | Delta Economics TCI-A Based Strategy, Currency Calls for April 2015
Source | Delta Economics


Delta Economics Trade Insight April 2015  |  Author  |  Rebecca Harding  |  CEO Delta Economics


Oil spill-overs

Why Iran’s role in the Iraq crisis is critical for everyone  |  Oil prices have climbed this month amid uncertainty about Iraq’s security as ISIS took control of Iraq’s second city, Mosul, and threatened to establish a Caliphate across Northern Iraq and Greater Syria. The region is oil-rich and the dangers of spillover into other countries in the region potentially puts further upward pressure on oil prices just as the crisis in Ukraine was beginning to be priced into markets generally and oil markets in particular.

Against this backdrop, the consequences of Iran’s decision to mobilise troops to fight against ISIS, thereby supporting the Iraqi government and, by implication the US. This clearly presents diplomatic and security challenges to the US: it does not support Iran’s backing of Syria’s Bashar al-Assad and the idea of the US and Iran being on the same side may be unpalatable to the White House.

Nevertheless, the Iranian move is shrewd. It supports Iraq’s Shiite government as a regional strategic partner and, wanting sanctions to be lifted as it does, is moving to protect its economic and trade interests as much as its political ones. The Delta Economics Q2 2014 forecast for trade growth in the MENA region generally is just over 0.6% lower than our forecast in Q1 at 4.5% growth during the course of the year. But Iran’s total trade will grow by nearly 5.5% and its exports of mineral fuels by over 17%. it clearly has a lot to gain from closer relations with both Iraq and with the rest of the world.



Figure 1  |  Oil Spillovers: Why Iran is increasingly important to the Middle East’s oil supply
Source  |  DeltaMetrics 2014


Asia is important as an export destination for Iranian mineral fuels, explained at least in part by the fact that sanctions have prevented substantial trade with Europe or North America historically. As a result, the country to watch is Turkey – simply because oil exports into Germany are routed through Turkey from Iran. Iran is Turkey’s largest crude oil importer.

From an Iranian perspective, however there is potentially a stabilising effect on oil markets that its decision to intervene in the crisis could have. If Iraq’s oil increasingly comes on tap, then any drop in oil supply from Iraq can be offset against increased supply from Iran. Figures 2 and 3 show how mineral fuel exports from both countries are predicted to perform to the end of 2014.

Figure 2 suggests that mineral fuel exports picked up sharply in the early part of 2014 but may suffer slightly from the fall-out of the current crisis in June and July, after then they will remain relatively static to the end of the year.



Figure 2  |  USDm value of Iraq’s mineral fuel exports, June 2001-Dec 2014
Source  |  DeltaMetrics 2014


Figure 3 shows that Iran’s mineral fuel exports will actually follow a similar pattern to Iraqi exports and fall slightly towards the end of Q2 and into Q3 picking up only slightly in Q4. Mineral fuel exports to Turkey have been declining fairly systematically since the beginning of 2013 which potentially reflects the fact that Turkey has supported Syrian opposition rather than Al-Assad in Syria.



Figure 3  |  USDm value of Iran’s mineral fuel exports, June 2001-Dec 2014
Source  |  DeltaMetrics 2014


Interestingly, however, this does not appear to have affected Germany’s imports from Iran which have increased since mid-way through 2012, despite the fact that sanctions still exist, reflecting, perhaps, Germany’s (and Europe’s) sustained concern about its energy security.

Crises in the Middle East always make markets nervous. Unsurprisingly the correlation with oil prices of MENA trade is very high at 0.98 since a higher value of oil trade historically also reflects higher oil prices. However, the correlation of MENA’s trade with key markets is very high: with the S&P 0.70, with Dax, 0.81, with the India BSE 0.91 and with the KOSPI, 0.92. If oil trade in the Middle East is weak, it makes both oil and equity markets nervous.

Remarkably, there is also a very strong correlation between Middle East mineral fuel exports with the Gold Spot last price monthly, as Figure 4 shows.


Figure 4  |  USDm value of Middle East mineral fuel exports versus NYSE Arca Gold Spot last price monthly, June 2001- May 2014
Source  |  DeltaMetrics 2014, Bloomberg


This correlation is very marked up to the middle of 2012 but has looked increasingly negative since then. Gold is often used as a hedge against price changes but while prices rose over this period in emerging markets, they declined in Europe breaking the relationship. In spite of that, the correlation over the whole period is over 0.90: if Middle Eastern oil trade goes up, then it means that oil wealth is increasing and that demand for gold, as a result, will be higher. If oil exports increase towards the end of the year, we can expect higher gold prices then but in the immediate future, further price declines.

The Middle East is increasingly a source of oil for Europe as it attempts to reduce its dependency on Russian oil. Yet as the region is fraught with geopolitical risks, there are dangers to the speed at which trade growth will increase, especially if the Iraq crisis spills over across the region. The major beneficiary nation, however, will be Iran whose mineral fuel trade is forecast to grow the fastest of any country in the region. This is the results of loosening sanctions and the desire, especially in Europe to have a broader energy supply base.

But it is also arguably the result of Iran’s policy to create a Shiite power-base within the region. While in the short term this may stabilize markets: pushing oil prices down as more oil becomes available during the course of the year. It might be that the effect is to increase the likelihood of a bull run next month because markets again price all the effects of the crisis in. However, the division of the region on religious grounds is also visible through its trade making it vulnerable and volatile. This may well have longer term spill-over effects.


Webcast 011 | Understanding fundamentals

Delta Economics is still concerned about the geo-political risks that are having a dampening effect on trade. Rebecca Harding looks at the reasons why Delta Economics is less positive about world trade in 2014 than the World Trade Organisation and points to the fact that global trade and Chinese and Japanese trade in particular has been weak in the first quarter of 2014. She reinforces the concerns about the fact that markets have become detached from economic fundamentals but points to new Delta research that shows just how closely correlated German exports are with the Dax over the last 10 years suggesting that this is the market that is more closely linked to economic fundamentals.


Webcast 011 Author  |  Rebecca Harding  |  CEO