Trade Insight February 2015

Currency wars and volatility


Executive summary

  • January 2015 was a volatile month with markets unsettled by the uncertainty generated at the beginning of the month over European Central Bank Quantitative Easing (QE). This uncertainty was compounded by the removal of the Swiss franc’s currency peg to the euro by the Swiss National Bank.
  • Both events have put significant pressure on the euro during the first month of 2015 which Delta Economics expects to continue throughout the year. We are forecasting that the euro and US dollar may well reach parity by the end of the year, if not earlier if current trends continue.
  • Delta Economics is expecting the PMIs published at the beginning of February to be broadly in line with consensus expectations. We expect China’s PMI to fall back while we are expecting PMIs in Europe to improve slightly. It is too soon to herald a recovery but this is a positive start to 2015.
  • The Delta Economics Asset Trade Corridor Index (TCI-A) reflects the underlying volatility in markets with Information Ratios largely negative for equities and currencies. The TCI-A has produced an average monthly paper return of 1.3% over the past 19 months. The average return on an equally weighted portfolio in January 2015 was 2.2%.
  • We expect oil prices and the value of the euro to fall during February. We expect other commodity prices to rise (against consensus), equities to rise and the US dollar to strengthen against most major Emerging Market currencies. However, the tightest strategy that we use suggests a strong downside risk to all these calls because of the underlying volatility reflected in the information ratios.


Greeks bearing gifts? The consequence of January for the euro in 2015


Delta Economics is of the view that the euro will reach parity with the US dollar by 2015 and has the potential to fall lower if current volatility and pressures on the currency continues. This is for several reasons:

First, Delta Economics considers the euro to have been over-valued for some time, largely as a result of the German trade surplus. Although Europe needs German trade to be strong because of the supply chains that originate in Germany and spread out across Europe, the high value of the euro has made it harder for the internal imbalances of the eurozone to be corrected by export-led growth outside of Germany.

At the outset, markets viewed the eurozone with a degree of scepticism. By June 2001 one euro bought 0.85 US dollars. As time has gone by, eurozone performance has, inevitably perhaps, become more dominated by Germany pushing the value of the euro up and kicking the issues of intrinsic imbalances between Member States down the road. However, instead of resolving imbalances by everyone “becoming more like Germany”, a weaker currency simply reflects the fact that everyone isn’t like Germany.

Second, the fact that QE was necessary in the first place made it abundantly clear that the eurozone is far from a marriage of equals. The euro came under pressure ahead of the announcement and fell to new lows subsequently. But it is here where the facts start to conflict with policy expectations. Theoretically, a lower euro should boost the real economy through trade because exports should become cheaper. However, what we’ve actually seen over the years since the introduction of the euro is a high correlation between the euro’s value and the value of trade: in other words, when the euro goes up, so does trade (Figure 1).

We believe there are two explanations for this: in the first instance, European trade, dominated as it is by Germany France, Italy, the Netherlands and Belgium, is largely at the high end of supply and value chains and therefore does not respond particularly to changes in the value of the currency. Even for weaker nations more dependent on commodities, the importance of Europe-wide supply chains means that the relationship still holds. For example, the correlation of the value of the euro with Greek trade is 0.89.

Furthermore, the value of the euro is actually a signal by the markets about the strength of the European economy: when the economy and institutions seem strong, the value is high and vice versa. In other words, as discussed previously, trade is an important driver of the value of the euro because of its importance as a driver of economic performance in the eurozone generally. While trade is falling, and we are forecasting it will fall by 3.7% within the eurozone in 2015, so too can we expect the value of the euro to fall. The result is that policy can have very little effect on the real economy through currency manipulation.




Figure 1  |  Monthly value of eurozone exports, USDbn versus USD per euro spot, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


The third reason why the value of the euro is likely to come under increased pressure is the outcome of the Greek election in January. Syriza is looking to renegotiate its debt and start the process of loosening the tight controls it has had over spending. It will not be helped by a lower-valued euro (Figure 2) because of its inter-dependency with trade in the eurozone as a whole through its role as a trade hub.




Figure 2  |  Monthly value of Greek total trade (USDm) versus USD per euro spot price, Last Price Monthly, June 2001-Dec 2015
Source  |  DeltaMetrics 2015, Bloomberg


Greece’s trade to GDP ratio is 0.4: in other words, there is a fairly strong pull of trade on Greece’s GDP. Oil is a critical part of this; the correlation between Greece’s trade and the oil price is 0.80 – largely because of the importance of oil in Greece’s total trade structure. Greece’s exports of refined oil, for example, are twice as high as the second-largest export sector – medicines.




Figure 3  |  Greece’s debt and the challenge of trade
Source  |  DeltaMetrics 2015


Greece’s trade is just 0.4% of Europe’s total trade; however, their trade is nevertheless important both because of the impact that it has on the prospective growth of the Greek economy and as a portent for the negotiations about debt restructuring, austerity and structural reform ahead. Put simply, if a low-valued euro is unlikely to help boost Greek (or eurozone for that matter) trade more generally, then there is little that monetary policy at a European level can do to help long-term growth in the peripheral nations. Greece’s debt is, according to Syriza, not repayable and imposes too many restrictions on the Greek economy. One option is to set debt repayments against growth targets but, given falling oil prices and falling intra-European trade, this looks ambitious.

The eurozone needs more than QE and a low value of the currency for growth. The eurozone’s peripheral nations’ struggle for growth is accentuated by the fact that they must trade in euros internally and externally. Given “austerity” constraints attached to their sovereign debt, this makes it very difficult to grow. There will continue to be sustained political dissent between Member States on the best way to resolve the issue of Greece, and there is a danger that the debate will spill over to other nations, like Spain, Ireland and Portugal.

The likely outcome of all of this is continued market pressure on the euro (Figure 4).




Figure 4  |  Monthly value of Eurozone exports versus USD per Euro spot price and linear forecast, Jan 2014-May 2016
Source  |  DeltaMetrics 2015, Bloomberg, Delta Economics analysis


The pressure on the euro over the last year has mostly been downwards. The Delta Economics asset price forecasting model, which is itself based on country-sector-partner trade flows, is indicating short positions on the euro for most of 2015. Even if the trend continues in a linear way as it has done over the past 12 months, this suggests parity by the end of the year.



Outlook for PMIs February 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.

Generally we are expecting manufacturing PMIs to move in line with consensus this month with very little movement on their December values. The only exception is French services where we are expecting a bigger increase in the service sector PMI compared to consensus. However, although the accuracy of the predictions has been reasonable over the past 12 months, the correlation is substantially lower.

The predictions are based on:

  • 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 (6 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).

Outlook for PMIs February 2015  |  Outlook risk

  • The above information is based on the PMI tickers as listed.
  • The predictive capacity of the model is strong, but not perfect as they are based on correlations rather than causal relationships
  • Note – the correlations and values given are against the Tickers listed and not with the Flash PMIs although the Flash PMIs follow similar patterns
  • Note – forecast values are indicative of scale of change only and should not be seen as absolute values



Figure 5  |  PMI outlook, February 2015
Source  |  Delta Economics



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 and asset price. It creates an optimum corridor index of those trade corridors each month and has been tracking its performance over the past 19 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: this 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, which are not optimised and based purely on an equally weighted portfolio strategy, were 2.2% in December 2014. This means that over the past 19 months, returns have averaged 1.3% per month with above average returns in 11 months.




Figure 6  |  TCI-A returns, June 2013-January 2015
Source  |  Delta Economics


The calls for February 2015 reflect underlying volatility in markets with Information Ratios largely negative or mildly positive. Although the TCI-As across a portfolio of assets produced a return of 0.7% in October, this was against a similar backdrop of low or negative Information Ratios, which arguably underpinned the correction in the middle of the month. Because of these low, even negative, IRs our portfolio suggestions potentially have substantial downside risk attached to them.





The short call on oil reflects continuing downward pressure on oil prices despite the mild rally at the end of January 2015. While the signal strength is low, the information ratio is high suggesting that this is a strong call. Similarly, the long call on Gold has weak information ratio but strong signal strength suggesting that Gold may continue its upward path as a hedge against deflation. Because of underlying uncertainties in the global economy and the fragility of commodity markets, the long calls on copper and steel appear contrary to market sentiment currently. However, our trade outlook for the world in 2015 is mildly more positive than it was during 2014 and Asia in particular is forecast to grow strongly. A long call on copper and steel suggests prices may start to increase during February as a lead indicator of manufacturing activity increases towards the end of Q1 2015.




Figure 7  |  Delta Economics TCI-A based strategy, commodity calls for February 2015
Source  |  Delta Economics analysis





We are expecting all equity markets to increase this month, but the signal strengths are weak and the Information Ratios largely negative. A long position arguably reflects the sustained flight to equities following European QE, but the negative information ratios reflect volatility and substantial downside risk.




Figure 8  |  Delta Economics TCI-A based strategy, equity calls for February 2015
Source  |  Delta Economics analysis






The calls generally suggest that the euro will continue its weaker path against the US dollar this month. The information ratio on this call is strong, but the signal strength relatively weak. Other emerging market currencies similarly paint a picture of a strengthening dollar as expectations of an increase in US interest rates later this year versus perceived weakness in Europe and Japan continue to stoke up its value.




Figure 9  |  Delta Economics TCI-A based strategy, equity calls for February 2015
Source  |  Delta Economics analysis



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


The Fallacy of Quantitative Easing

There is no doubt the EU project has benefited the German economy above all else: a bit like the cat got all the cream and then some. But it cannot be put off any longer; as Voltaire once said, with great power comes great responsibility. In an unusual act of defiance against German apprehension to the ECB’s sovereign bond-buying programme, the ECB will press ahead with QE1. There will be a week to thrash out the exact details after the ECJ verdict on 14th January on the legality of such a move, but a formal announcement is expected on 22nd January.

The decision to “press the button” is more likely now than ever before given the falling prices in the Eurozone. Some would argue that we are being too quick to diagnose a deflationary spiral: that these are just temporary falls in prices. The truth is that falling prices were evident in the Eurozone long before the recent external (oil) supply shock took effect. Europe’s problems run much deeper.

In the short term, any announcement in QE is unlikely to be large enough or make a significant impact on economic fundamentals: much like plugging holes in a leaking dam. QE will only act as a plaster over the real structural differences that besiege the Eurozone. Indeed, some of the world’s major economies have implemented QE with dubious results: the USA has been through three rounds of QE with more favourable outcomes, however, whether that’s purely down to QE or other more dynamic variables has yet to be proven. The UK has gone through two rounds: with the first being more effective than the second. Japan on the other hand has had to endure NINE rounds of injections (yes, QE9!) with little effect. Even after 20+ years, the legacy of deflation is engrained and growth remains elusive.

In the more medium term, what is clear is that QE will contribute to bloating banks’ balance sheets, with little in the way of affecting the real economy. This is unlikely to prompt banks to lend more. On the contrary, the winners of QE will be the bond holders, mostly the well-off, whom are unlikely to spread to the gains evenly around the economy, but would rather pile into assets thus further perpetuating asset price inflation. It’s an inefficient allocation of resources: the “wrong” people are being targeted.

What else if not QE one might ask? Recent reports suggest that Japan is toying with the idea of implementing a more innovative monetary policy tool known as “helicopter money”: dropping money directly into the pockets of every citizen. Whilst this would target the “right” people, it may all be too radical for the bureaucrats of Europe. Many economists view this measure with great suspicion partly because it hasn’t been tested robustly enough. However, the belief that prices will fall further may already be entrenched into the minds of EU citizen, so any windfall in the way of helicopter money (if too small) may be squirrelled away rather than spent on stimulating the local economy. Introducing a voucher- based system for certain goods and services is marginally better, but this too comes with a host of complications in terms of which good and services qualify, and ensuring money is not leaked out of the system.
It will need more than QE to resuscitate the Eurozone. A Eurozone break up is out of the question no matter how necessary it may be in economic terms: politics will trump economics. What is more likely is that there will be QE-light – but this still falls short of what is really needed: further structural reforms and deeper fiscal consolidation. One thing is for sure: being timid never got anyone anywhere…


The Fallacy of Quantitative Easing  |  Author  |  Shefali Enaker  |  Economist

What goes up…

Why markets should recover but uncertainty will remain |  For almost all of this year, Delta Economics has been arguing that global equities are long overdue a correction. The reason for this is simple: there is a high correlation between trade values and the global markets (68% for the FTSE and S&P 500 and 85% for the Dax). There is an even higher correlation between trade and emerging market equities at over 90% for the Kospi. If the Delta Economics forecast for trade growth is flat, then it should stand to reason that markets will also underperform.

But, as Figure 1 shows, what goes up appears to be going up forever. Since the bull-run began, trade has been relatively flat while markets have reached unprecedented heights. Even the putative crisis in emerging markets at the beginning of 2014 failed to have a lasting impact on equities generally despite ever-more negative news about trade.




Figure 1  |  Value of World Trade (USDbn) vs S&P 500, Last Price Monthly, June 2001-Dec 2014
Source  |  DeltaMetrics, 2014, Bloomberg


As markets do not consider trade data as market-leading, this should not be a surprise. What appeared to happen during the second week of October was that market analysts reacted to suspicions that interest rates might rise and that Quantitative Easing might stop in October. Simultaneously they realised that the Ebola crisis in Africa could have an economic impact while tumbling oil prices raised a spectre of disinflation and poor German data put the Eurozone crisis back in the spotlight.

So is this the moment where Delta Economics steps back and says, “We told you so”? The short answer is no, not yet. We are expecting markets to continue to recover their lost ground in October, but for volatility to remain high. We are forecasting a seasonal pick-up in trade, which means that Purchasing Managers’ Indices may well show some sign of recovery at the end of the month. This could spur equities if not to new heights, then at least to reverse the correction earlier this month (Figure 2).



Figure 2  |  Eurozone PMI (normalised value) versus Eurozone Delta Trade Corridor Index (Sentiment) change (June 2001-Dec 2014)
Source  |  Delta Economics analysis


The Delta Trade Corridor Index-Sentiment (TCI-S) measures the change in a country’s or region’s trade against its PMI. For the Eurozone, the correlation is 86% thus the slight pick-up we expect to see in trade this month is likely to be accompanied by a similar increase in the value of the Eurozone’s PMI. Similarly, we expect the PMI to improve for China and the US as well.

This is nothing more than a seasonal fluctuation and it is always a mistake to react to one month of data. Instead, it is more useful to look at the macroeconomic momentum. This is precisely what the TCI-S measures: the way in which trade is changing over time. What is clear from Figure 2 is that the Eurozone trend is downwards; the same is the case for the Global Manufacturing PMI, as measured in Figure 3.



Figure 3  |  Global manufacturing PMI normalised values vs Global Delta TCI-S change
Source  |  Delta Economics analysis


Figure 3 presents a more worrying picture of momentum: that well into Q2 next year will be the earliest we see any pick-up in our TCI-S or trade more generally. After an increase this month, the next five are likely to be weaker with the TCI-S turning negative.

The reason for this has as much to do the uncertainty caused by geopolitical risks as it does with macroeconomics; these risks will affect emerging markets in particular. While conditions remain uncertain, investment will be held back and it is likely that Africa will suffer first. Since March 2014 we have seen a year-on-year decline of 8% in West Africa’s trade. Further, we are expecting Chinese imports from West Africa to halve (from over 16% to 8% growth) in 2014. With falling oil and commodity prices generally, this represents a perfect storm for investment in Africa.




Second, Turkey is likely to suffer substantial economic fallout from the Iraq crisis. Turkey’s trade with Iraq alone is worth some USD11.6bn. Much of this trade is in oil and, although Iraq’s oil reserves are largely in the South rather than the ISIS-controlled North, we are still forecasting a 21% reduction in its imports from Iraq to January 2015. We also expect a 23% reduction in its trade with Syria over the same period.

Finally, oil prices have not risen as a result of the crises in the Middle East or in Ukraine although this may have been expected. Instead, prices have fallen as Saudi Arabia has increased its oil supply and as the USA, now the world’s largest oil producer has loosened its restrictions on exports. Trade values and oil prices are 94% correlated and our forecast of 0.56% trade growth in 2014 suggests that oil prices are set to fall further (Figure 4).



Figure 4  |  Value of world trade (USDbn) vs NYSE ARCA oil spot, Last Price Monthly, June 2001-Dec 2014
Source  |  DeltaMetrics, 2014, Bloomberg


The falling price of oil is a double-edged sword: while it lowers costs, it also raises the spectre of deflation, which is increasingly causing concern amongst analysts. If prices turn negative then it threatens global economic growth – as witnessed in the latest downgrading of IMF economic and trade forecasts.

Delta Economics is of the view that the IMF and WTO forecasts for trade growth, at over 3.1%, have still not sufficiently factored in the effects of falling oil prices. Based on data produced by the CPB Netherlands Bureau’s World Trade Monitor, the Delta Economics forecast still appears to be closer to actual trade than that of either the IMF or the WTO (Figure 5).



Figure 5  |  World Trade Organisation and Delta Economics World Trade Forecasts versus actual
Source  |  Delta Economics analysis


We are expecting a temporary increase in world trade in October that could well boost markets for the remainder of the month. However, we are also expecting trade to drop back considerably into the first quarter of 2015. The immediate reaction to the return of volatility in the early part of August must surely have been, “What goes up must come down” and over the longer term, we expect continued uncertainty to fuel volatility in markets. The potential for a major correction before the year end cannot be discounted. However, in the very short term, the reverse might well be the case: what goes down must surely come up again.



Webcast 016 | Whisky and aspirin: is this the future of Europe?

In light of Delta Economics negative forecast for European growth, CEO Rebecca Harding and OMFIF Founder David Marsh explore the reasons behind the slowing in trade and how it is affected by, amongst other things, the recent slowing in Asian markets and uncompetitiveness. The discussion also examines the internal imbalances in the European economy, with particular emphasis on Germany and also looks at some of the fundamental differences between countries such as Greece and Spain with a view to understanding differences in trade growth patterns. This webcast also discusses the relatively positive trade growth in European periphery economies as well as they challenges they will face in the short and longer term.


Webcast 016 Author  |  Rebecca Harding  |  CEO

Running out of energy

Why Europe needs Germany to sort out its energy policy  |  The last thing Europe needs right now is a crisis. With the ECB’s decision to take interest rates into negative territory last week, it rekindled the spectre of disinflation turning into deflation in the Eurozone. If this wasn’t enough, fears about Europe’s dependency on Russian oil as the crisis in Ukraine continues appeared to be abated slightly as Germany appeared to open up the potential for shale gas production and then shut it again saying that the exploratory work would stop well short of allowing fracking to resume.

This matters because Germany’s trade is 98% correlated with its imports of mineral fuels, including shale [Figure 1].



Figure 1  |   USDm value of Germany total exports and its imports of mineral fuels June 2001-Dec 2014
Source  |  DeltaMetrics 2014


Germany is undeniable the export engine of Europe and its energy consumption (measured through imports) is so tightly related to the value of its exports that its energy policy becomes vital, not just to the country itself but also to the rest of Europe. Eight of Germany’s 17 reactors were closed after the Fukushima disaster and a commitment to close the remainder by 2022 was made, leaving Germany without a major source of internally generated energy and a need to rapidly find an alternative. In addition, much of Germany’s energy is produced in its own coal and lignite mines making it arguably increasingly dependent on one of the most polluting types of fossil fuel, despite its reputation for being at the leading edge of environmental technologies.

So are there signs in Germany’s trade that it is becoming either more green in terms of its energy production or consumption or that it is reducing its dependence on Russia for oil?

The short answer to this is not really as Figures 2a and 2b show.




Figure 2a (top) and Figure 2b (bottom)  |
German imports or exports of mineral fuel products as a proportion of all mineral fuel imports or exports, 2014
Source  |  DeltaMetrics 2014


Although imports of crude oil are forecast to decline by 2014, imports of refined oil are set to increase by a similar amount. Imports of electrical energy, which is all energy produced from non fossil fuel sources and so includes nuclear and alternative sources of energy are forecast to increase slightly.

The picture for exports sheds some more light on why there is no real change in Germany’s energy consumption. Although imports of refined oil are set to increase, its exports are set to decrease suggesting that Germany will become more, not less, dependent on outside of its borders for refined oil. Even though exports of electrical energy are set to increase by nearly 3% between 2014 and 2020, suggesting greater production from non-nuclear and renewable sources, it is still insufficient to offset Germany’s greater demand for refined oil.

However, although the Netherlands is by far and away Germany’s largest import partner of refined oil, its oil comes from Belgium, the UK and Russia in almost equal proportions; Belgium gets its oil from the Netherlands, Russia and the UK. Figure 3 shows, the dependency of Germany on Russian oil is substantial.



Figure 3  |  Running out of energy suppliers;
Why Germany is likely to be dependent on Russian oil for some time to come
Source  |  DeltaMetrics 2014


Countries like the UAE, Mexico, Angola and Iraq are all fast-growing suppliers of crude oil into Germany. However, adding up the total import values for each of the five fastest growing economies yields a total of USD 1.7 billion which is just one seventeenth of the total value of Russian imports of crude oil into Germany alone. More than this, Russian imports of both crude and refined oil are more highly correlated with German trade that imports from the UK, the Netherlands (refined) or Norway (crude). While oil imports from the UK are highly correlated with German trade, they are also forecast to remain static in the case of UK imports of refined oil and to fall by over 6% in the case of UK imports of crude oil.

There is still a long way to go; renewable energy alone will not reduce the dependency that Germany, and therefore Europe, has on Russia. Figure 4 shows how, despite a brief drop in imports into Germany during 2014, as a consequence of the current geopolitical uncertainty, Russia’s imports into Germany will continue to grow into 2015 and 2016 in current prices.


Figure 4  |  USDm value of Germany’s crude oil imports from its top three import partners, June 2001-Dec 2015
Source  |  DeltaMetrics 2014


It is likely that the Netherlands will pick up the slack as imports drop from Russia during 2014 but as it is similarly reliant on Russian oil this simply shifts the fulcrum temporarily rather than generating a real change.

Over and above everything else this is important because Germany’s trade is 87% correlated with the value of the Euro against the dollar and 76% correlated with the value of the FTSE. Given the even higher correlation at the moment of Germany’s trade with oil, this renders the concerns over its energy security not just understandable but actually critical if Europe is to avoid an economic crisis caused by geo-political uncertainty.

This brings us back to the opening statement. What Europe needs least is another crisis. There is evidence of growth in demand and the Delta Economics forecast for trade, although flat, is a considerable improvement on the negative outlook of six months ago. Yet a closer examination of Figure 1 shows something worrying: in current prices, Germany’s trade growth is relatively flat too. In other words, the slow growth in value terms of trade over the past few years and into the next two years, is not just because of slow global demand conditions, especially in Asia. It is also because there is downward, disinflationary pressure on prices which is flattening the real value of trade as shown in Figure 5 which looks at German exports against gold prices.



Figure 5  |  German exports, USDm value June 2001-May 2015 versus Gold Spot, Last Price Monthly, June 2001-May 2014
Source  |  DeltaMetrics 2014, Bloomberg


The correlation between German exports and the Gold Spot price is high at 0.79 (compared to 0.78 and 0.77 for the EU 28 and the Eurozone exports respectively). Gold is a hedge against deflation and we are beginning to see strong disinflationary tendencies if not deflation itself. At present that correlation remains positive because deflation has been on the horizon for a while, so markets are pricing it in at present.

However, if the Ukraine crisis deepens and Russian oil to Europe is shut off, then this will have a profound effect on German trade, pushing its real current value down and, hence, adding to deflationary tendencies. There is a real danger that the European recovery may be threatened by Germany’s trade, quite literally, running out of energy.



Own Goal?

Why Brazil needed to think beyond winning the World Cup on home turf  |  That Brazil might not be in the World Cup final on July 13th is to many Brazilians and football pundits around the world unthinkable. It is a shame that similar confidence cannot be applied to the Brazilian preparations for the World Cup or, indeed to the Brazilian economy more generally. Brazil, in the words of a German trade agency official, is the country that is “always going to promise growth just around the corner”.

Take Foreign Direct Investment (FDI) as an example. Since its peak in 2008 to the end of 2014, Delta Economics anticipates that it will have grown by just under 20% in nominal value terms despite the World Cup, the need for infrastructure around newly found oil reserves and the promises of a Latin American automotive hub. This includes a drop of 45% between 2008 and 2009, a subsequent 66% recovery and then growth of just 0.6% in 2012. Delta Economics anticipates that the forecast 6.8% growth in FDI this year will be nearly 1% lower than growth in 2013. Combined with flatter growth, high inflation and high interest rates, it is small wonder that the failure of the economy to deliver growth has frustrated investors as much as the failure of the World Cup to delivery prosperity has frustrated people.

The reason why interest rates are so high is not just to keep inflation under control, it is also to keep the value of the Real from tumbling. The Real-USD spot price is negatively correlated (-0.69) with Brazil’s total trade: after all, Brazil’s potential is defined by its capacity to become the Latin American growth engine with both natural resources, energy and manufacturing capacity to fuel its trade surplus (Figure 1).



Figure 1  |  Brazil’s total trade (USDm) June 2001-April 2015 vs Real per USD, Last Price Monthly, June 2001- April 2014

Source  |  DeltaMetrics 2014, Bloomberg


Except for the period during the financial crisis the value of the Real rose with trade consistently to the middle of 2011 but has slipped back against the US Dollar since then. Trade has similarly slipped back since then. What this suggests is that the currency is driven by increases in trade because investors see this as a route to growth in the economy and therefore returns. The currency itself has not necessarily influenced trade itself: as the currency has strengthed, so has trade, although, as a surplus nation, it might be expected that Brazil’s exports in particular would drop of with a strengthening currency.

By way of confirmation that there is a large speculative element in Brazil’s currency valuation, its Terms of Trade are not particular correlated with the value of the Real (Figure 2), but they are highly correlated with the oil price (0.89).



Figure 2  |  Brazil’s terms of trade (value of exports in terms of the value of imports), June 2001-April 2015, vs Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  DeltaMetrics 2014, Bloomberg


What this suggests is that neither export nor import growth is particularly influenced by the value of the currency. This is because of the strong speculative element to the value of the Real which means that investment has little connection with the economic fundamentals in the economy – only its potential. The correlation with the oil price is unsurprising because it simply reflects the dominance of oil in Brazil’s trade structure.

And this structure of trade has changed little over the last 12 years. The Finger-Kreinin Index (FKI), which compares the structure of trade in one country against others, suggests that while other BRIC countries have become more like Brazil, Brazil itself has failed to capitalise on its manufacturing potential seen a decade ago in its car sector.

In the context of an imminent World Cup tournament, the irony that the Brazilian car sector is dominated by German manufacturers is not lost. As Figures 3 and 4 show, Brazil’s exports to Germany are most strongly correlated with the value of the Real of all its top five export partners. This is simple to explain: exports to the Netherlands are largely in oil, to the US are in Maize and Oil, to Japan in iron ore and oil and to China in iron ore, oil and soya.



Figure 3  |  Correlation of Brazil’s exports to its top five export partners with Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  Delta Economics analysis


Why should exports to Germany be more correlated with the value of the Real (Figure 4)? Perhaps it is because of the potential in that trade relationship: inward investment from German manufacturers has promised much for Brazil: innovative automotive production plants with a strong supply of automotive components from Argentina were regarded as the engine of a competitive nation that could move from being highly commodity dependent to one that could skip the intermediate manufacturing seen in other BRICs and focus on high-end automotives. Anticipating the



Figure 4  |  Value of Brazil’s exports to Germany (USDm), June 2001-April 2015 vs Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  DeltaMetrics 2014, Bloomberg


But Germany is Brazil’s fifth largest export destination and although the relationship has promised much, reflected in the high correlation it has disappointed investors, hence the pressure on the Real now.

Brazil is an increasingly open economy with trade anticipated to account for 46% of GDP in 2014 rising to 52% in 2018. However, this reflects two things in our forecast: flatter projected GDP and the dominance of commodities in its structure of exports in particular (Figure 5). While there is evidence that Brazilians are increasingly demanding more sophisticated products (automotive imports are forecast to grow 14% in 2014 while bio-pharmaceuticals are forecast to grow by nearly 12%, for example), the fact that two of the fastest growing import sectors are printing and ancillary machinery and telephone equipment suggests that infrastructures are still growing at catch-up rates.


Click to view larger version

Figure 5  |  Where is the infrastructure?

Source  |  DeltaMetrics 2014


If Germany is the country amongst Brazil’s top importers that has the most to offer in terms of higher end export potential then Figure 5 also presents a more worrying picture. The fastest growing import sectors from Germany into Brazil do not reflect infrastructure development, but do reflect greater consumer demand for telephones, air-conditioning, medicines and medical equipment. The largest import sectors from Germany are similar: cars, medicines, car parts, fertilisers and biopharmaceuticals. Out of the fastest growing import sectors from Germany, the ones most correlated with infrastructure rank 25-30: pumps, car parts, machinery related to rubber and plastic processing, lifting & handling machinery and internal combustion engines.

It is not the place of an economist to predict who is going to be in the World Cup final, still less to predict might win it. But consensus (measured through the odds) of a Brazil-Germany final is not out of the question. Brazil must hope that, if this happens, it can avoid the own goals that have plagued the infrastructure and trade development since it was announced as the host nation for the 2014 tournament.

Be wary what you wish for

Why the anti-European protest movement is missing the point | As the dust settles from last week’s European Elections one thing will be quite clear: there is a real momentum behind anti-establishment and Euro-sceptic protest parties across the continent.  From the “Alternative für Deutschland” (AfD) party promoting Germany’s exit from the Euro, through the Front Nationale in France, to UKIP (UK Independence Party) advocating the UK’s exit from Europe altogether, the mistrust in established politicians is manifest.  Beyond the clear fact that voters are frustrated with national politicians, the core of Euro-sceptic sentiment is rooted in anger, indeed frustration, at the failure of Europe’s politicians to create economic security for its voters because of the tortured recovery from the financial and sovereign debt crisis, perceived threats to job security from immigration and a failure of European institutions more generally.

As Europe and the UK’s mainstream politicians start to re-calibrate their dialogue with the electorate about Europe, they would do well to focus on trade, not least because one of the two founding principles of the European Union was free trade between Member States.

Trade is central to understanding why European Union is important.  First, take the country with the most vocal advocates of European exit, the UK.  Trade with Europe was worth an estimated £301bn to the UK economy in 2013 and the Centre for European Reform (CER) estimates that some 30% of the UK’s total trade is reliant on membership with the EU.  Second, there are signs that economic conditions in Europe are improving: our forecast for European trade has risen from a negative forecast for 2014 three months ago to a flat growth forecast (-0.08%) now reflecting an improvement in underlying drivers of trade included in Delta’s model, including lower market volatility, improved GDP and greater migration which improves the downward pressure on trade of aging populations.

Europe remains a long way from sustained growth, still less rapid growth, but there are positive signs of internal rebalancing since Mario Draghi’s commitment to “do whatever it takes” to ensure that the Euro did not collapse.  But while Mr Draghi concentrated on the need for the ECB to shore up the Euro as required, the Delta Economics view is that Europe’s longer-term solutions lie in its international competitiveness represented through its external trade balance.  Figure 1 shows why we see this as the case.



Figure 1 | The Value of EU 28 and Eurozone trade (USDm) versus the USD per Euro exchange rate, Lat Price Monthly, June 2001-April 2014


What is remarkable about the relationship between the value of Europe’s and the Eurozone’s exports and the USD-Euro currency spot price is the strength of the correlations: 0.86 NS 0.87 respectively.  In itself, this helps to explain why, even at the depth of the sovereign-debt crisis there was never a serious or sustained run on the Euro.  The currency is a trade currency and this means that it is less vulnerable to speculative volatility.

Similarly, European markets are also highly correlated with EU28 and Eurozone trade.  Taking the DAX as a proxy, the correlations are 0.76 and 0.75 respectively, as illustrated in Figure 2.




Figure 2 | The value of EU 28 and Eurozone Exports (USDm), June 2001-Dec 2016 versus the DAX Last Price Monthly, June 2001-April 2014


Figure 2 shows a weaker correlation with the value of the Euro since mid 2011 for the Eurozone reflecting the sovereign debt crisis, the relationship between  EU 28 trade and the value of the Euro has remained strong, suggesting that the DAX reflects the economic fundamentals of trade to a greater extent than does, say, the FTSE 100.

Figure 3, which shows the relationship between the value of the UK’s exports to the EU and shows that, although the relationship is weaker (correlation of 0.69) the UK’s trade relationship with Europe is an important driver of market sentiment.




Figure 3 | Value of UK exports to the EU (USDm), June 2001-Dec 2016 vs FTSE 100 Last Price Monthly, June 2001-April 2014


What all this suggests is that the value of the Euro and key European stock markets are highly linked with European trade generally and UK trade with Europe in particular.  The UK’s trade with Europe is even reasonably correlated with the value of the DAX at 0.64.  In other words, markets can use trade statistics as a proxy for underlying fundamentals and react accordingly. Indeed, unlike the S&P 500, which appears to have gone in the opposite direction to trade recently, European markets seem to reflect European trade quite closely.  The conclusion? That Euro-sceptic political parties do not need to worry as much as they thought about economic mismanagement if a focus on long term growth, competitiveness and trade can supersede the shorter-term focus on austerity and rebalancing over time.

During the course of the next year, however, Europe’s politicians need to worry about the consequences of a potential UK exit from Europe, following the proposed referendum should the Conservatives win the next election.  The debate will focus around the benefits to the UK of European membership and a cursory look at the correlations between the USD-Euro, Sterling-Euro and Sterling-Dollar spot prices confirms that the value that the UK extracts from its EU in currency terms is far less than the value that the EU gets from its trade with the UK.



Figure 4 | Why Europe matters to the UK
Source | Delta Economics (Estimated proportion of trade dependant on EU – Centre for European Reform)


The correlations are much stronger between UK trade with Europe and the value of the Euro than they are for the value of Sterling, particularly against the Euro where the correlation is minimal.

This is hardly likely to have an impact on the average British voter, however, and, far from suggesting that the UK’s trade with Europe is valueless in currency terms, the fact that the correlations are weaker simply illustrates how the value of Sterling is more volatile in response to market sentiment rather than economic fundamentals.  Actually, as Figure 4 suggests, the value to the UK economy of trade with Europe is significant and, if the UK were to exit from the EU then the country would lose some £425bn, or over £6,000 per head of population in lost export trade value by 2022.

More than this: our forecasting model suggests that trade is highly correlated with skills, at some 0.98 across key countries in the European Union, the US and India.  In other words, across the developed and the emerging world, higher skills lead to more trade.  Here the UK has a gap with its European competitors: the skills component of trade is actually mildly negatively correlated with trade itself at -0.30 where it is 0.98 in other European countries.  In other words, the bulk of UK trade is currently not skills dependent and on the face of it may actually benefit from having lower skills (and hence lower costs) associated with it. Similarly innovation is only mildly positively correlated with UK trade at 0.35.

Two other countries with skills and innovation correlations like this are Brazil and China suggesting that the UK could easily lose out to lower cost nations if the bulk of its trade remains at this lower value end unless it can find cheaper ways of producing the same goods. Reports in May suggested that migration may actually have a positive effect on trade by reducing costs.

But there are two significant issues with assuming a low cost-low skill trade base for the UK is adequate. The first is one of principle: the UK should remain competitive at the higher value end of goods trade where innovation and skills are highly correlated with trade and where cost is less important. It is imperative that it increases the innovation component of its trade and recruits people with the skills to work in an innovative and international environment.  The second is one of practicality: if the UK is to find the people to take these roles, then it will have to compete with the rest of Europe as well as emerging economies like India which have high correlations of trade with skills and innovation. Accessing wider skills and innovative capacity through immigration is a central pillar of a strategy to build high-end competitive.  For example, Germany, having identified skills shortages in its productive and exporting base a decade or longer ago, now has its highest net-migration since 1993.

If Europe’s economy is improving, the benefits of trade to individual member states so great and the benefits of migration in skills and innovation terms so clear, Eurosceptics would do well to remember to be wary what they wish for.


A dose of its own medicine

Why India has a clear way of boosting its economy through exports  |  When Mr. Modi takes office on the 21st May, his first thoughts will almost certainly not turn to US pharmaceutical imports, but maybe they should. India has been plagued by a trade deficit since 2006 which is likely to grow in double digits this year and next. Alongside this, its terms of trade (the value of its exports in relation to the value of its imports) have deteriorated substantially and although its share of world trade increased to above 2.5% in 2013 and is forecast to reach 3% by 2015, this is as much because of increases in imports as it is about increases in exports. The Rupee’s value against the US Dollar has slipped by over a third in the three years since May 2011 when confidence in emerging markets generally and India in particular was so strong but if Mr. Modi is to address some of the broader challenges he faces, then it is the link between trade, real economy and key indicators such as the value of the Rupee that he needs to tackle first.

This will not be a simple job because, at the moment, the speculative element in Indian markets and the dominance of its trade by imports means that the correlation between the currency and exports is relatively weak at 0.50. The correlation is slightly stronger between its imports and the value of its currency at 0.53, as shown in Figure 1, which illustrates something unusual about the relationship: as the currency becomes weaker, imports drop.


Figure 1  |  Indian imports (USDm value, June 2001-April 2015)
against Rupees per USD, Last Price Monthly, June 2001- April 2014
Source  |  DeltaMetrics 2014, Bloomberg


India imports predominantly crude oil, which, with an estimated value of USD 175bn in 2014, is nearly three times higher than the next largest import – gold. If the currency devalues, then exports should become more competitive and imports less competitive since they are more expensive. India has increased its imports of oil over the time since 2006 by over 350% against a backdrop of a depreciating currency making it inflation-prone.

But this relationship also demonstrates the fact that India’s currency is prone to speculation. The correlation is weak against commodity exports and this suggests that it is not so much measuring the economic development and growth of the Indian economy as it is measuring the capacity of the economy to soak up imports from overseas. The Indian stock market is a measure of the investment potential of the Indian economy and it too is more strongly correlated with imports (0.91) than it is with exports (0.90), as illustrated in Figure 2.


Figure 2  |  Indian imports (USDm value, June 2001-April 2015) vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg


While the difference in the correlation between the BSE and exports and imports is marginal, it points to the fact that investors are, arguably, measuring the success of the economy against their own capacity to invest in it. The post-dotcom hubris that surrounded India’s development in the early 2000’s spawned an excitement about India’s potential growth that fuelled inward investments in biotechnology, pharmaceuticals and electronics from developed world economies, particularly the United States. And yet, paradoxically perhaps, India’s trade itself has shifted markedly away from the developed world economies and towards economies in the Middle East and Asia.



Figure 3  |  Moving focus – how India’s trade is shifting from Europe to Asia and the Middle East
Source  |  DeltaMetrics 2014


For example, China was India’s twelfth largest export destination in 2001 but is its third largest now and Singapore was its eleventh but fourth largest now. The UK was India’s fourth largest export destination but is now 7th and Germany its fifth, but is now 8th. India’s fastest growing export destinations are Indonesia, Vietnam and Brazil and while the UAE has risen from second to first, much of this is because of exports of diamonds, jewellery and gold.

Its import structure has changed as well, reflecting India’s insatiable demand for oil, diamonds, gold and jewellery. In 2001 the UAE was ranked 14th and Saudia Arabia are nexus pheromones any good 18th. They are now 2nd and 3rd respectively. China is the number one importer and with import values into India of USD 71.9bn anticipated in 2014, its imports are worth more than twice those from Switzerland and the United States which ranked first and second in 2001.

Trade is normally glacial in the pace at which it changes so these shifts in the structure of India’s trade partners are worth dwelling on. The pattern that is being reflected is a shift away from the developed world towards the emerging world and while this is, in itself, not a bad thing, it pushes India’s trade structure increasingly towards that of an emerging economy. Its trade is heavily concentrated in refined oil (nearly 19% of its exports) and pearls, precious stones, precious metals and jewellery (16%). Pharmaceuticals overall account for around 3% and while this is more than its concentration ratio of 2.5% in 2001, it is modest in comparison to its commodity exports.

Exports to the emerging economies are largely commodity-based: for example, exports to Vietnam are dominated by beef and soyabean cakes, maize and fish while exports to Brazil are oil, synthetic filament thread (used to stitch car seats), carbon and coke and insecticides. Yet to Germany, its top five export sectors include aircraft parts and cars, while to the US they include medicines.

It would be a mistake for policy makers to ignore the importance of traditional areas of export strength. Precious metal, pearl and jewellery exports to the UAE, for example are strongly correlated with the value of the currency at 0.61, as shown in Figure 4.


Figure 4  |  Exports of pearls, precious stones, precious metals and jewellery (USDm) to the UAE,
June 2001-April 2015 against Rupees per USD, June 2001-April 2014, Last Price Monthly

Source  |  DeltaMetrics 2014, Bloomberg


It would also be misguided to ignore the importance of emerging markets in Asia. As Figure 5 shows, there is a very strong correlation (0.91) between the value of India’s Iron Ore exports to China and the Indian Stock Exchange.


Figure 5  |  Indian exports of ores, slag and ash to China (USDm value, June 2001-April 2015)
vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg


Indian pharmaceutical exports to the United States, however, are almost as highly correlated with the BSE at 0.88 and this is important for policy makers. Over the period since 2001, the comparative advantage of Indian pharmaceuticals has gone from positive to negative and while the comparative disadvantage of Indian electronics exports (measured through revealed comparative advantage) has gone from -0.66 to -0.46, given the powerhouse that is India’s innovation economy, this should be reflected in its electronics exports as well. Yet the correlation between India’s trade and proxies for its innovation (the amount the government spends on R&D and business expenditure on R&D) are very high at over 0.93 as are skills, wages and foreign direct investment. More than this, the currency elasticity of trade is 0.99 correlated with trade.

All of this gives Mr. Modi’s team a clear lever to stimulate the economy. First, in the short term, the currency should be kept weak – this will have the effect of closing the trade deficit simply because the responsiveness of trade to changes in the currency is so high. This will promote exports in areas where price competitiveness is key, such as oil or iron ore, or even beef, which is a fast growing export product.

Second, India’s new government needs to think about its long term growth which will only come from extending education into rural communities, building on its high level skills base in cities and innovation – building on its successes in software and business services as well as in pharmaceuticals. South-South trade between emerging economies is commodity and infrastructure focuses and Delta Economics is not positive about its pace of growth in the immediate future. Accordingly, as the developed world begins to emerge from the financial crisis, India needs to take a dose of its own medicine to re-connect with these markets as they will help it to restore its competitive advantage in the innovative sectors that were so vibrant ten years ago.

Well Oiled?

Why Russia’s threats on gas will not damage European growth | The good news: the European economy is beginning to look healthier. In the first full week of April, data suggested that German, Italian and French industrial production rose in February and Greece took its first steps back into bond markets buoyed by an IMF report stating that austerity was paying off, but there was still a long way to go. The bad news: President Putin has warned Europe that its gas supplies could be cut off because of a long-standing dispute with the Ukraine about non-payment of its bills. What impact is this likely to have on Europe and what is the threat to Europe’s fragile recovery?

Since 2009 when Russia halted gas supplies through the Ukraine for similar reasons, Europe’s oil and gas has been less reliant on supplies through the Druzhba pipeline that runs through the Ukraine; its supplies increasingly come from the Nord Stream pipeline directly from Russia. This makes Europe more dependent on Russia, but not as dependent on the Ukraine. In fact, the Ukraine does not feature in the top ten direct oil or gas importers into the European Union because its oil and gas is supplied from Russia (Figure 1a, 1b, 1c – ordered top to bottom).




Figure 1a/1b/1c | European importers of crude and refined oil and gas, share of total imports 2014

Figure 1 Source | DeltaMetrics 2014

The charts are, of course, slightly under-stating the extent of Russia’s influence in the oil and gas sector. For example, the Netherlands is the largest importer of refined oil into the rest of Europe but its third largest importer of refined oil is Russia, illustrating Russia’s pervasive influence across the region. That said, it is likely to be Germany, as the largest economy and the one that is most reliant on Russian oil and gas, that will be most affected. The drop in imports of oil and gas that we are currently forecasting up to the end of August 2014, is very marked, as shown in Figure 2.


Figure 2 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 2 Source | DeltaMetrics 2014

The forecasted decline in German oil and gas imports in the second two quarters of 2014 is marked. For example, we expect imports in April 2014 to be around 6% below their value in 2013, in July to be nearly 2% below and in August over 3% below their 2013 year-on-year values. However, this is part of a general downward trend in the second two quarters of this year as we are expecting similarly lower values for imports of oil and gas into Germany from the UK and from Norway.

This points to a more general issue: after a bruising few years, the recovery in Europe is acknowledged to be fragile and nervousness about its vulnerability has affected markets in the early part of April. Yet the Euro remains strong against the dollar and the Delta Economics trade forecast for Europe in 2014 shows a mild improvement since Q4 last year: from a net decline in exports forecast for 2014 of 0.3% to flat-lining growth now. This helps to explain the strength of the Euro: trade is a good proxy for competitiveness and, using Germany as the Penis Enlargement Eurozone’s strongest trading nation for illustrative purposes, as trade improves, the value of the Euro against the US dollar appreciates.


Figure 3 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 3 Source | DeltaMetrics 2014, Bloomberg

But while no-one has questioned the strength of Germany and its trade competitiveness, the competitiveness of the peripheral regions has been a concern of both investors and policy makers alike since the sovereign debt crisis. Even here there is evidence that Greece and Portugal in particular are beginning to pull through. Austerity measures have been tough but wages are falling and competitiveness measured this way is beginning to be restored even if circumstances remain tough for businesses and people in those countries. Delta Economics is forecasting that Greek merchandise trade will grow by 3% this year and Portugal’s by over 4%. These are above average for the European Union; more than that, there is a similarly strong relationship between the value of the Euro and their trade, illustrated in Figure 4.


Figure 4 | Greek and Portuguese exports versus USD per Euro, Last Price Monthly, June 2001-March 2014

Figure 4 Source | DeltaMetrics 2014, Bloomberg

What is really intriguing about this chart is that, compared with Germany, the correlation of exports with the USD-Euro exchange rate is almost as high for Portugal and higher for Greece. For Greece, the whole time period correlation is 0.86 while for Germany it is 0.85.

Maybe, then, we should be looking to Greece and its trade routes as a bellwether for the European economy after all. The Greek trade economy is proportionately small but where the Greek economy as a whole appears more stable and on a path to recovery, it certainly calms market nerves and signals that the policies that have been implemented may gradually be having an impact on competitiveness and the risks of further bailouts or contagion reduced. Greece’s largest export product is refined oil accounting for some 26% of its exports, and Delta Economics is forecasting that this trade will grow by 8% in this year and next. In itself, this helps explain the relative buoyancy of Greece’s exports. Iron and steel bars will grow by 6% and steel tubes and piping by nearly 7% and it is the role that Greece is playing as a transit hub for oil, gas and infrastructure products that is really gathering pace, albeit from a low base.

One note of caution: Greece does produce oil itself but it also imports a great deal of oil for export. Its largest import partner is Russia with volumes some ten times higher than the next import partner, India. While India’s imports are growing rapidly (at 11% over the next two years), this will not be sufficient to reduce Greece’s trade dependency on Russian oil. There are risks to Greek trade, and they are linked to the crisis in Russia, but its restored attractiveness as a trade and transit hub across a range of sectors will grow as its competitiveness continues further giving it the opportunity to broaden its exports beyond a dependency on Russian oil. The trends augur well but we should also remember the words from ancient Greece, “A ship should not ride on a single anchor, nor live on a single hope.”

Even a stopped clock….?

Why economists are right to be cautious about the recovery | In a recent after-dinner speech at an Economists’ event I attended, a senior UK economist and a former external member of the Monetary Policy Committee explained why economists are cautious about stating unequivocally that the recovery in the UK and Europe has started. The argument ran something like this: first, economists generally as a profession did not predict the downturn; second, although there are plenty of individuals who will state that they knew it was coming, it was not predicted in our models and therefore we should be wary of declaring recovery – just in case everything collapses again; third, there are plenty of signs that any recovery in 2014 is weak and is unlikely lead to global “escape velocity”, as Christine Lagarde, the Head of the IMF reminded us last week.

As the World Trade Organisation (WTO) looks back into its crystal ball on the 14th April, tells us what happened to merchandise trade in 2013 and revises what it thinks will happen in 2014, it would do well to remember the humility with which all economists should treat any forecast. In a sense, its job is easy. It is revising its forecasts for 2013 and therefore 2014. It is likely to come in at a trade growth figure for 2013 around 1.9% in contrast to its forecast of 2.5% for last year. This will mean that it will also have to revise downwards its forecast for 2014 as it will be starting from a lower base but, because it is using the more optimistic assumptions modelled by the IMF of faster growth in developed countries, it will still be very optimistic on trade growth for the year.

Delta Economics’ own estimate of trade growth in 2013 suggests that trade growth has been lower than the 1.9% that the WT0 was informally predicting back in December at just 1.4% averaging out imports and export growth. Our modelling is based on the monthly IMF Direction of Trade Statistics, the United Nations Comtrade Statistics and 93 national statistics offices. The first two are the same datasets that the WTO itself uses, the third harmonises the data with national data to bring it up to date.


Figure 1 | Delta Economics Q1 2014 World Trade Forecast overview

Figure 1 Source | DeltaMetrics 2014

Given that the data is similar to that used by the WTO, it is hard to see why it would come in with a value as high as 1.9%, but estimating techniques vary and the figure of 1.5% growth in imports in 2013 without a correction for global disinflation may explain the difference.

However, what matters more is the fact that the Delta Economics forecast for world trade growth in 2014 has been falling over the past six months and will, no doubt, be several percentage points below that of the WTO’s which currently stands at 4.5% for 2014. While, like the WTO/IMF’s forecasts, we saw more buoyant conditions at the end of 2013 but even so, the moving average forecast over the past 6 months suggests that world trade growth in 2014 will be only just above 1% compared to 1.5% that we were forecasting in December.

There are several reasons why Delta Economics is cautious about predicting a rapid expansion in trade growth this year. The first is that, as Figure 1 suggests, while we are more positive about the US, Germany and the UK, we are more negative or neutral about exports from other top trading nations: China, France and Japan. Our forecasts are also more negative for other, key, economies such as Canada, Mexico, India, Saudi Arabia and the UAE. This leads us to have a generally more negative outlook for export growth in every region except Europe and for Europe we are forecasting a slightly slower contraction rather than growth.

The second reason why we are less positive about trade is because of the patterns of trade between developed and emerging economies. The main feature of the post-crisis recovery was a more rapid recovery of emerging economies in trade terms compared to developed nations, shown in Figure 2.


Figure 2 | North-North and South-South trade, June 2001-Dec 2016 (USDbn values)

Figure 2 Source | DeltaMetrics 2014

North-North trade has yet to return to its pre-crisis levels and will remain flat for the next three years according to our forecasts, but more importantly, South-South trade, which drove trade recovery after the downturn globally, will grow by just over 5% in 2014 compared to over 18% in nominal values between 2011 and 2012. And since this is predominantly accounted for by commodities, infrastructure and intermediate manufactured goods, it suggests that these economies will not be demanding the products that fuel growth for the foreseeable future. Declining export forecasts for China, India and Mexico, as well as slower forecast growth in Asia, Latin America and MENA illustrates just how the spillover effects of South-South slowdown work through to these countries.

Some of the fall in prices is because of how trade is measured. We, like the IMF and the WTO, use US Dollar nominal values to create our trends but what this does, is illustrate very clearly that if there has been downward pressure on prices this, in and for itself would explain why we are showing slower actual growth. The current price forecasts that Delta Economics models, effectively show how trade volumes will be affected if prices remain the same. On the basis of this, we are forecasting only modest growth in South-South and flat growth in North-North trade volumes.

Why this is important is because of the effect that it has on equity markets in particular. For example, the BSE Sensex is highly correlated with South-South trade (0.92) and this is illustratively presented in Figure 3.


Figure 3 | South-South trade and the Indian BSE Sensex last price monthly, June 2001-Feb 2014

Figure 3 Source | DeltaMetrics 2014

When equity prices generally fell between 2007 and the end of 2008, the subsequent lock-down in credit affected markets for trade finance with the result that South-South trade fell as well after a time-lag. The upward trend of the market and emerging world trade continues until the end of 2010 when again, a drop in the market created uncertainties, particularly about India’s trade and economic performance and again led to a drop in trade after a four month time lag.

And this matters at a global level as well. Figure 4 replicates the same diagram for the S&P 500 and world trade.


Figure 4 | S&P last price monthly and value of World trade, USD bn, June 2001-Feb 2014

Figure 4 Source | DeltaMetrics 2014

Since 2001, equity prices and trade have been highly correlated. In 2008 we saw a major drop in equity prices and the simultaneous lock-down of credit. What this did was restrict access to trade finance with the consequential 23% drop in trade that we saw in 2009. They moved together with a high positive correlation up to April 2011 reflecting general confidence in markets, but, since then, the relationship has been an equally strong negative correlation.

What this tells us is that markets have not been reacting to economic fundamentals for the last nearly 3 years but instead are reacting to sentiment and political/geo-political events. This makes them volatile, which, as our modelling demonstrates, increases uncertainty and therefore trade itself. It also suggests that there is a correction due during the course of 2014 if we are to return to the high levels of correlation up to 2011.

There is plenty to worry about in world trade at the moment. It is not like GDP in that it is directly affected by geo-political risk, which often works through trade sanctions and embargoes, and it is directly affected by economic uncertainty because this makes the trade finance environment more difficult and can restrict access to finance for exporters. This in and for itself will negatively impact GDP and economic development through trade.

Given the importance of trade to markets, trade finance and to economies generally, improving the accuracy and timeliness of trade forecasts is vital. Delta Economics is erring on the side of caution in proclaiming a recovery, not because it is insuring itself against the likelihood of a downturn but because the geo-political and deflationary downside risks globally suggest that the trade picture is more negative than is currently being predicted elsewhere. Trade, like financial markets, is internationally inter-dependent – one falls and the other falls too. It is no longer adequate to be like a stopped clock – right twice a day.