Webcast 035 | UK Economic prospects for the next five years

Ahead of the Queen’s speech, Delta’s CEO Rebecca Harding talks to Frances Coppola and Shaun Richards about the UK’s economic priorities for the next parliament.


Webcast 035 Author  |  Rebecca Harding  |  CEO

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


Growth, currencies and interest rates

Four trade challenges to monetary policy  |  Short summary:


The Fed needs to be careful about the next monetary steps it takes because:

  1. The growth effects of Quantitative Easing (QE) in Europe are yet to be felt, if indeed they will be
  2. Neither China nor Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia
  3. The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus
  4. Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences



In its bi-annual report to Congress, the US Department of the Treasury, International Affairs, assessed the macroeconomic policies of its major trading partners to see if inappropriate activities are being used to manipulate the balance of trade with the US. It urged the governments of Germany, China, South Korea and Japan to do everything in their power to eliminate global economic imbalances by focusing on reducing their trade surpluses with the US and halting practices of competitive devaluation against the US dollar. Against a backdrop of strong US growth and weaker growth elsewhere, the report argued that addressing these imbalances through structural reform, monetary and fiscal policy was the only way of ensuring that the G20 balanced global growth targets were met.


Four trade reasons why monetary policy alone can’t create real growth:


1  |  The growth effects of QE in Europe are yet to be felt, if indeed they will be

The immediate effect of QE has been to push European equity markets to new highs and push down the value of the euro against the USD. It is unlikely to create real, export-led growth since the correlation of the euro with Europe’s trade is positive (i.e. an increase in the value increases trade). Where it does have an effect on boosting trade, it is likely to be felt most strongly in Germany. This will potentially exacerbate the problem of its trade surplus, particularly with the US (Figure 1).



Figure 1  |  Monthly Value of German Exports to the US (USDm), June 2001 – December 2015 vs. EUR-USD, Last Price Monthly, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg


The chart shows a positive correlation (0.67): in other words, as the value of the euro increases, so too do exports. This reflects the relative exchange rate inelasticity of trade between Germany and the US. Growth in exports from Germany to the US has been modest over the past two years and the sharp reduction in the value of the euro does not appear to be likely to make much difference to its trade balance with the US.

The weaker euro is unlikely to impact Europe’s or, more specifically, Germany’s trade surplus with the US. Indeed, it is also unlikely to lead to greater demand without an accompanying non-monetary policy in Europe, such as infrastructural spending and structural reform to boost both demand and competitiveness.


2  |  Neither China nor South Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia

The yuan is kept within a 2% peg of the US dollar and, as such, has been increasing its value since the end of 2004 when the currency was first allowed to float. More recently, March 2015, the yuan has appreciated against the US dollar giving rise to speculation that the peg is about to be loosened or removed completely (Figure 2).




Figure 2  |  Monthly Value of Chinese Exports to the US (USDbn) vs. USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


The impact of the appreciation of the yuan is to suggest that Chinese exports to the US may flatten slightly during 2015. This provides some cause for optimism around the size of its trade surplus with the US. Of greater concern from a US perspective may be Russia’s decision to price oil and gas deals with China in yuan. This suggests that the yuan’s role as a trade finance currency is growing and that there will be further strengthening of the currency. This is likely to be a result of both a loosening of the peg and the role of the yuan as a trade finance currency. The threat of a stronger yuan and the prospect of a future currency war may be more unpalatable than the trade surplus now.

The won is slightly different in that it is only very weakly correlated with South Korea’s exports to the US at -0.46. In other words, any devaluation by the Korean monetary authorities is unlikely to have much, if any, impact on its trade surplus with the US. Given the speed that the Kospi has picked up since QE in Europe has prompted greater liquidity, the US would do well to look at the consequences of capital outflows and rising dollar-denominated debt as Asia’s slowdown works through. Priced in local currencies, such as the won, the markets look buoyant; priced in dollars, the rises are less substantial and represent both a loss in earning and pose a threat when dollar-denominated debt has to be repaid.


3  |  The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus

Japan’s QE programme has resulted in a substantial devaluation of the yen against the US dollar. However, this has not had the desired impact of increasing all exports to the world or the US in particular (Figure 3). Export-led growth has not materialised despite substantial QE-induced devaluation since the onset of Abenomics.




Figure 3  |  Monthly Value of Japanese Exports to the US vs. USD-JPY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


In fact, if anything, exports to the US from Japan have been falling ever since the start of the most recent phase of QE in Japan. Alongside this, Japan’s imports from the US have been increasing and could grow by nearly 5% in 2015 as a result of Japan’s greater external energy dependency after Fukushima.


4  |  Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences

The US Fed is now in a bind: its challenge is not the monetary policy of its trading partners, it is the unforeseen consequences of its next monetary moves. The US dollar is strong and while some of this is because the US economy itself is doing well compared with other economies, its strength is more than partly due to the fact that markets are speculating on when the Fed will put up rates. Fuelled by both QE and uncertainty around the announcement of a rise in rates, it is likely that the USD and the euro will reach parity imminently, if not by the end of April then during May. Similarly, the yen is hitting new lows against the USD.

The euro and the yen’s values are already distorted by the effects of QE. Alongside this, any increase in interest rates will exacerbate the dollar’s strength against the currencies of all its major trade partners except China. While currencies weaken, equity markets including the Dax, Nikkei, the HSI and the Kospi continue bull runs that are the direct result of large amounts of liquidity made cheaper, not just by low interest rates, but also by weaker currencies. The result will undoubtedly be aggravated by a rise in US rates: a strong US dollar is not necessarily the best for the US in the long run if corporate earnings, confidence and exports falter.

2020 chocolate shortage

A number of recent reports have predicted a global chocolate shortage by 2020. Unfortunately, Delta Economics forecasts that these concerns could be merited. The trade data shows that demand for chocolate will continue at a high rate to 2020, but cocoa exporters (predominately within Africa) will struggle to meet this demand with a corresponding increase in exports.

Over the next five years demand for chocolate is expected to experience steady growth. In Asia, we expect demand to grow at an annualised rate of 7% to 2020. Interestingly, however, it is not from Asia, that the highest rates of demand for chocolate can be found. Demand for chocolate from the MENA region is expected to increase at an annualized rate of over 8% over the same period. North American demand for imported chocolate is also expected to increase by 6% annually to 2020.

Over the next five years, the largest cocoa exporting nations, the Ivory Coast, Ghana, Nigeria and Cameroon, are all expected to see growth in cocoa exports. However, these rates of growth are significantly lower than the expected increase in global demand for chocolate. This increases the pressure on cocoa farmers and the implications for African agricultural industries are severe. In Ghana, for example, the cocoa industry employs around 800,000 families and has given rise to the saying “cocoa is Ghana, Ghana is cocoa”.

Without investment to maintain sustainable conditions for productivity, there will be little impetus for growth and cocoa farmers will be unable to meet growing demand. However, with adequate policy measures in place, there could be a prosperous future for farmers, producers and consumers alike.


2020 chocolate shortage  |  Author  |  Nayani Bandara  |  Analyst and Project Manager

Asset Management | Asset of the month: EUR/USD

Delta Economics’ asset price forecasting model is giving strong indications that the euro will weaken in April, in line with the model’s predictions that there will be EUR/USD parity by the end of 2015. We forecast a highly volatile month for the euro, with high resistance given that parity is a psychological barrier, particularly in light of the upcoming UK elections and continuing anxiety around a Grexit.

We suggest short positions for the current month and expect that the euro could go as low as 1.01 against the dollar in April. Our analyses show it could reach 1.0035 at an extreme.

The weakness of the euro is a direct product of the confusion created by the European Central Bank’s implementation of Quantitative Easing in March, seen as both too little, too late, and given broader uncertainty around the effectiveness of the strategy. Further, a weak euro is linked to a strong USD, in turn a product of the anticipation of a rise in interest rates, as well as weaknesses evident in Asian markets. The dollar will strengthen further nearing parity, which Delta Economics’ expects to see after April.

Medium term nervousness around sustained Greek membership of the eurozone and contagion effects of any debt renegotiation is putting further downwards pressure on the euro: this pressure is likely to intensify in the coming few weeks. We expect major movements in the market at the start of April, with high volatility throughout the month.



Webcast 031 | QE, Central Banks and Europe’s Future

As the ECB’s Quantitative Easing programme gets underway in an attempt to reflate the eurozone, questions remain over how effective it will be. Rebecca Harding and Shaun Richards discuss.


Webcast 031 Author  |  Rebecca Harding  |  CEO

Wild Card: The Rag Trade

As London Fashion week gets into full swing, Delta Economics forecasts that 2015 will be a good year for British fashion with furs, shoes, wool-fabric dresses and handbags particularly show-casing the best of British fashion in 2015.

So according to the trade data, what’s on trend this year? We forecast that furs are definitely in this year with the UK’s exports expected to grow by 8% during 2015. Shoes and handbags are also expected to see strong growth at 5.5% and 1.8%, respectively.

The top three destinations for UK handbags and shoes are Germany, France and Italy. So expect to see plenty of British style in Berlin, Paris and Milan this year. For example, shoe exports to Germany and France will be around 5%, while exports to Italy will be 3.5%.

However, silk is definitely out in 2015. Exports are forecast to decline by over 12% and imports by 9%. UK exports of cotton will also decline by nearly 1% while imports will increase by a paltry 1% during 2015. We’ll be importing hats at a similar rate to 2015 (0.5% growth) but our exports are forecast to fall by over 7%.

Perhaps as a nod to austerity Britain, imports of second hand clothes will be growing at nearly 2% during the course of the year – slightly faster than the rate at which we export second hand clothes.



Figure 1  |  The Rag Trade
Source  |  DeltaMetrics 2015



The Rag Trade  |  Author  |  Rebecca Harding  |  CEO

China’s nerves of steel

Why January’s drop in exports may not be such bad news |  Chinese exports in January 2015 fell by 3.3% compared to a year earlier. Its imports fell by over 19%. Analysts had expected exports to grow by over 6% and the slowdown in imports to be less marked than it was. The Hang Seng Index (HSI), which has a high correlation with Chinese exports, dipped slightly on the news but had rallied by the end of the week.

Delta Economics views this rally as temporary: seasonal volatility in Chinese trade in January and February coupled with lower commodity prices means that we are likely to see a further drop in the value of China’s exports in February. Although the trend during the course of the year for the HSI is positive, lower trade could impact substantially on the value of the HSI until the end of Q1 2015 (Figure 1).




Figure 1  |  Monthly value of Chinese exports (USDbn) vs Hang Seng Index, LPM, June 2001-Dec 2015 (forecast)
Source  |  Delta Economics, Bloomberg


Of particular concern to analysts was the drop in imports in January. China’s trade is 83% correlated with oil prices and therefore the recent drop in oil prices goes some way to explaining the fall. Further, a more general drop in commodity prices would also have impacted on China’s import trade values for January: China’s trade is 61% correlated with steel prices for example. Given that we expect an increase of 5.8% in iron and steel trade in 2015, compared to 2.4% in 2014, it would be reasonable to conclude that seasonal effects and falling commodity prices are more likely to be responsible for January’s, and potentially February’s, drop in trade values rather than a drop in demand.

Iron and Steel trade is a good proxy for infrastructure development and economic growth within China. China is a net importer of Iron and Steel, the largest products within which are flat rolled alloy steel and hot rolled steel products. China’s exports predominantly go to emerging markets in Asia while China’s imports come from South Korea, Japan, Europe and the United States. China has a net trade deficit in iron and steel, yet to its key export partners, its market penetration is above average for the world.




Figure 2  |  Rebalancing of Iron and Steel trade
Source  |  Delta Economics, Bloomberg


The clearest indication of a reorientation of Chinese policy away from export and infrastructure-led growth in favour of demand-led growth can be found in its reimports of iron and steel. These are products that originate in China but are exported and then reimported from Chinese territories or Special Administrative Regions (such as Hong Kong, Macao or Taiwan). Over the past two years reimports have been slowing which suggests that China is utilising its internal resources less – arguably reducing its stockpiles.

Chinese trade, and particularly its iron and steel trade, matters for the rest of the world. But its importance is not as a proxy for the health of the Chinese economy. Instead, it matters because markets perceive it as a bellwether for the health of the Asian economy. For example, the HSI is 81% correlated with Chinese trade and 89% with the KOSPI. Similarly the Australian dollar’s correlation with Chinese iron and steel trade is 82%. While these do not reflect causality they do suggest that regional market sentiment and trade are strongly associated.




Figure 3  |  Monthly value of iron and steel trade (USDm) versus USD-CNY spot, Last Price Monthly
Source  |  Delta Economics, Bloomberg


Weaker trade data in the first part of 2015 is likely to result in a depreciation of the yuan (Figure 3). In recent months there has been a slight revaluation of the yuan but we see it depreciating further over the next two quarters as trade growth remains sluggish after it spikes in March. The correlation is negative at -82%: in other words, a currency depreciation will have a positive impact on iron and steel trade, because the currency elasticity of commodities is high.

This will have broader consequences for the rest of the world, not least by potentially aggravating trade relations between the USA and China by making US imports into China more expensive. It would also make European imports into China more expensive and, at a time when the European economy is looking to re-establish its growth, the importance of the Chinese market cannot be understated.

Once again this demonstrates the power that China has to manipulate its own performance and therefore to impact the economies of the rest of the world. Emerging markets equities are likely to react negatively to slower Chinese trade in the short term while the Australian dollar may well become weaker against the US dollar because it is so influenced by the performance of the Chinese economy generally and trade in particular.

If the yuan devalues further, this also has the potential to threaten any export-led growth that may be developing in Europe and the export-fuelled growth that the US is enjoying. The broader geopolitical risks of embarking on a currency war to protect China’s domestic interests as it restructures would stall trade negotiations at the very least. The hope is there will be no devaluation as China seeks to restructure its economy. The outlook for trade towards the end of 2015 and into 2016 for China is certainly brighter, but to get through the first quarter at least of 2015 markets and analysts will need to have nerves of steel.

Webcast 029 | Europe at a Crossroads

Delta Economics CEO, Dr Rebecca Harding and the Associate Editor of Pieria Frances Coppola, discuss the effect that Quantitative Easing may have on the European economy and some of its likely consequences for businesses. They also analyse issues surrounding Greek debt and weaknesses in the Russian economy.



Webcast 029 Author  |  Rebecca Harding  |  CEO

Webcast 028 | Back to reality

Why Dollar-Euro parity is possible  |  January was a turbulent month in markets and politics. There was really only one story in town: European quantitative easing and the Greek election. What does this mean for trade and markets?



Webcast 028 Author  |  Rebecca Harding  |  CEO