Three reasons why the Fed should not raise rates  |  The rampant US dollar went relatively unnoticed until the end of last week as the world’s attention was diverted towards Europe and the start of Quantitative Easing (QE). It gained almost 4% against the so-called “BRICSA” and “MINT” currencies, the South Korean won and the Thai baht in the first two weeks of March. Since these countries have almost $US 870bn in dollar-denominated debt, all of a sudden the dollar’s strength appears to be the world’s weakness in the long term. And as markets are increasingly expecting a small increase in US interest rates in June, the Fed should at least consider the international consequences of that decision.

Quite apart from anything else, it highlights just how integrated the post-crisis world is through the global financial and trading systems and, increasingly, monetary policy as well. At its extreme, there is no such thing as “national” monetary policy: Central Banks, including the Fed, do not set interest rates for a closed economy. Their actions have global repercussions and at no time in recent economic history has this been clearer as June, and therefore the prospect for a hike in Fed rates, gets closer.

Delta Economics is of the view that if the Fed raised interest rates it would be damaging the prospects for long- term economic growth in the US. This is not because the US economy is weak. Rather, it is because the risk of sovereign default on the dollar denominated debt becomes greater as the dollar gets stronger. Beyond the simple cost of repayment, there are three things that make default likelier and therefore the consequences for the US economy more severe.


1. Currency depreciation does not necessarily lead to export growth

First, it cannot be assumed that there is an automatic link between currency depreciation and greater exports. The Thai baht, for example, shows how for some countries there is an inverse relationship between the currency’s value and its trade: as the spot rate decreases (in other words the baht appreciates) trade increases (Figure 1a). This is also the case for some of the other, most indebted, Emerging Market economies: for example, Brazil ($188bn debt), China ($213,7bn), South Korea ($82.3bn) and Thailand ($14.6tn) (Figure 1b ).


2015-03-17_fedUp_fig01a_v03 2015-03-18_fedUp_fig01b_v05


Figure 1a  |  Monthly value of Thailand’s exports versus USDTHB, Last Price Monthly, June 2001-Dec 2015 (forecast)
Source  |  DeltaMetrics 2015, Bloomberg

Figure 1b  |  Selected Emerging Market currencies’ correlation with trade growth, June 2001-March 2015
Source  |  Delta Economics analysis


Conversely, the positive correlations are not as strong as they should be for a country to benefit from a depreciation in its currency. For South Africa and Russia there is a very low correlation indeed, while for Indonesia, India and Turkey the correlations are higher but still moderate. Only Nigeria and Mexico have stronger correlations between the value of their currency and trade. This suggests that they are in highly competitive markets (such as oil and intermediate manufactured goods) where the responsiveness of trade to a change in the value of the currency is likely to be higher.

However small a rise in Fed interest rates may be, the dollar’s value would increase and therefore make emerging market debt more expensive. Because there is not a clear-cut and positive impact on trade, Emerging Market economies are unlikely to have the export-led growth effects that will make that debt affordable.


2. Oil Price Losers

The dominance of oil in the structure of Emerging Market trade is made obvious by the extraordinarily high correlation between oil prices and total trade (Figure 2).




Figure 2  |  Correlation of total trade with oil prices, selected Emerging Market economies, June 2001-March 2015
Source  |  Delta Economics analysis


The lowest correlation of trade with oil price is China at 0.81, but for countries like Indonesia and Mexico the correlation is much higher at 0.90 and 0.89, respectively. What this suggests is that trade will increase as oil prices rise and vice versa. This is simply a reflection of the importance of oil in the structure of trade of Emerging Economies: because of its dominance, its correlation with the price of oil is very strong.

But because of the oil dependency of trade for many Emerging Markets, the fact that trade will drop in real terms means that all nations are potential losers from the fall in oil prices. This is either because their revenues from oil exports have dropped or because their trade overall has dropped. Again, this makes it tougher for any export-led growth to materialise.


3. Over-valued EM equities

The story of Emerging Market equity growth in the period since the financial crisis is one of expectations exceeding outcomes. The extraordinary recovery of trade and economic growth after the crisis pulled capital into Emerging Markets in anticipation of growth in the future. The strong correlation of most Emerging Market equities with trade through the 2001-2015 period illustrates the strength of these expectations manifested in investments in Emerging Market equities.




Figure 3  |  Correlation between emerging market equities and exports, June 2001-March 2015
Source  |  Delta Economics analysis


Interestingly, only China and Nigeria exhibit weaker relationships between their markets and trade. However, China’s trade is 0.94 correlated with the Hang Seng Index and Nigeria’s market is proportionately under-developed through the time period.

What this shows is that if trade falls back, there is a strong likelihood that Emerging Market equities will also fall. Consequently, this will reduce the amount of capital flows into these economies. Again, the net effect is to dampen economic strength but, equally, potentially to create a self-fulfilling prophecy: trade effects feed lower capital flows which in turn lead to a decline in trade because of a lower capital base.


So what does the Fed do?

The Fed should not raise interest rates unless it is prepared to write off the emerging market debt that is denominated in US dollars. Monetary policy has become international as well as national and it may well be that the United States’ long-term interests are not served by a strong US dollar. Emerging Market trade, oil prices and the value of Emerging Market currencies, and over-valued EM equities may seem unorthodox reasons for keeping interest rates on hold. But in the long term, it is the US that will lose if the debts cannot be repaid.

Greece’s future is its past

Why trade holds the key to debt renegotiation  |  A deal was done at the last minute: Greece’s €172bn debt bailout was extended for a further four months after a turbulent week of bluff and counterbluff. Even now, there are no formal agreements on the required reform process ahead and without these agreements the deal will not be ratified. It appears that the Greek government is keen to demonstrate its willingness to reform by focusing on tax evasion and civil service reform, but it is unlikely that this will be sufficient for either Germany or the ECB.

By letting its focus continue to be on austerity, debt renegotiation, and structural reform, Syriza and now the Greek government, seem intent on playing by the same rules as the Troika, the ECB and Germany. For an economy that has shrunk by 25% since the beginning of the financial crisis, this is extraordinary. Instead it should be looking at debt re-payment over the longer term. If an economy is growing, then its debt is affordable; if the debt is extended for four months, then growth should be made central to subsequent discussions.

At present the outlook does not look good for several reasons: first, Greece is a service economy yet, despite the improving external position represented by the declining euro, its service sector trade is set to decline sharply over the next three years and pick up only gradually into 2019 (Figure 1). Given Greece’s already weak domestic demand, the decline in service exports, which includes tourism, is worrying.




Figure 1  |  Outlook for Greek service sector trade to 2020
Source  |  DeltaMetrics 2015


Second, Greece’s goods 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. For example, Greece’s exports of refined oil are twice as high as the second-largest export sector: medicines.




Figure 2  |  Greece’s debt and the challenge of trade
Source  |  DeltaMetrics 2015


The importance of oil to Greece’s trade explains its resistance to the EU’s extension of sanctions against Russia in January and is the third reason why Greece’s situation more broadly looks vulnerable. Turkey is Greece’s largest trading partner and its import/export portfolio is dominated by oil, gas, cars and infrastructural products. Russia is a growing trade partner for Greece but Russia predominantly exports oil and commodities while Greece exports clothes and fresh or stoned fruit to Russia. Greece’s growth in exports since the financial crisis has been because of its role as an oil and infrastructure distributor with a heavy reliance on Turkey, its largest trading partner and, increasingly, Russia (Figure 3).




Figure 3  |  Greek imports from Turkey and Greece (% annual change) 2010-2016
Source  |  DeltaMetrics 2015


Imports from both countries have been volatile, but two things are clear: First, Greece has been attempting to switch its imports of oil from Turkey to Russia, evidenced by the steep increase in imports in 2010 from a small base. Second, and arguably more interestingly, imports from Turkey and Russia have been inverse to one another: when Russian imports have increased, Turkish imports have declined and vice versa. Even in the forecast period, from 2015 to 2016, Greece’s imports from Russia are falling at a slower rate than those from Turkey.

If Greece is to have a path to debt repayment then it must do two things: First it must seek to restore its greatness as a trading nation, both in services and goods, through reforms that focus on skills development, innovation, inward investment and port redevelopment. Supply side reforms alongside structural reform may make debt serviceable more quickly than just one in isolation since both are necessary and neither is alone sufficient.

But second, and in spite of history, Turkey may yet hold the key to Greece’s growth through trade and this is a bullet that should be bitten quickly. Europe’s geopolitical relationship with Russia is difficult at present to say the least and while this continues, it is unlikely that Greece will be able to restore its role as an energy and infrastructure distributor in the near future. Greece’s trade relationship with Turkey reflects mutual trade interests.

Market nervousness about the possibility of a “Grexit” heightened by the rhetoric of the past week may yet prove to be unfounded, however. The Greek public voted for Europe but against austerity. This is as much about politics as it is about economics. Greece, in trade and geopolitical terms, sits on an emerging fault-line between Russia and Europe. As sanctions build against Russia, Greece’s position is arguably more secure within Europe than it is, say, aligned with two of its major and more volatile trading partners, Turkey and Russia. And let’s not forget, the history defined by the Stability and Growth Pact and monetary union means Germany’s banks are exposed to the risks of Greece’s sovereign default and of a Grexit more than any other nations. “Necessity is the mother of invention”: let us hope that the Realpolitik of a Grexit is the driver for the resolution of the crisis.


Greece’s future is its past  |  Author  |  Rebecca Harding  |  CEO

Dragons and Eagles and Bears, oh my! Geopolitics among global powers

Dragons and Eagles and Bears, oh my! Geopolitics among global powers in 2015  |  Tensions between the world’s major powers are expected to continue in 2015 but are unlikely to develop beyond sabre-rattling. At this stage, we expect potential crises (for example, in the South China Seas in Asia and Moldova and Ukraine in Europe) to have greater regional, rather than global, significance. However, oil prices are a potential flashpoint with global repercussions.

A recent report released by the Eurasia Group wrote that 2015 will herald the return of geopolitics; in reality, geopolitics never went away. At Delta Economics we identify trends and patterns in world trade so the implications of political events for markets have long been evident in our forecasts. Indeed, in the run-up to a geopolitical crisis we often see a noticeable impact on trade.

For example, analysis of the historical trade data in the years before the 2008 Georgia conflict shows an unprecedented increase in Russian trade with Georgia (Figure 1). Interestingly, this increase began almost immediately after Putin’s State of the Nation Address during which he declared that ‘the collapse of the Soviet Union was the greatest geopolitical catastrophe of the century’.



Figure 1  | Russia-Georgia Total Trade, 2001-2008
Source | DeltaMetrics 2015


In fact, trade may even anticipate social and political upheaval in a timely manner. For example, in the months preceding the revolution in Ukraine last year we noted a substantial year-on-year spike in Ukraine’s imports of riot gear and ammunition from Russia at 20.1% and 13.6%, respectively. This was compared with just 1.8% growth in Ukraine’s imports generally.

So what do we think will happen in 2015? Relations between the major global powers have not been this strained for decades and China, Russia and the US are likely to continue to dominate the headlines. Our trade data reflects this suggesting ever-strengthening trade patterns on clearly delineated East-West lines: for example, Russia’s trade is set to spike in 2015 according to our latest estimates prompted by at 14.5% increase in trade with China and an 8.8% increase in trade with Iran. This compares with growth in trade with the US which we expect to fall from nearly 12% growth in 2014 to 4% growth in 2015.


In spite of a weakening economy, Russia is still a threat to European stability |  The crisis in Ukraine has not been resolved. Russia is certain to continue to support separatists in the Donbas, while the West is also likely to keep sanctions in place. This will leave the Ukrainian economy in precarious position. We expect Ukrainian exports to continue to suffer, contracting from 0.5% in 2014 to -0.2% in 2015.

Another region to keep an eye on in 2015 is Moldova. The country is politically significant to both the EU and Russia. It has been a “frozen conflict” since violence broke out in the breakaway region of Transnistria in 1992. Russia responded by stationing a small number of troops and a large arms stockpile. Russia also continues to offer the region substantial financial support.

However, an election in late 2014 saw Moldova deepen ties with Europe, with pro-European voters gaining 45.5% of the vote. This unlikely to sit well with Russia or the 370,000 ethnic Russians of Transnistria who accused Moldova of rigging the vote. Figure 2 shows that we expect a substantial increase in both imports and exports to Moldova to 2017. Worryingly, the trade pattern seems to reflect the spike in trade seen before the Georgia Conflict (Figure 1).



Figure 2  | Russia-Moldova Total Trade, 2013-2017
Source | DeltaMetrics 2015


We expect China to continue to challenge US hegemony, but tensions may flare with neighbours in the South China Seas  |  Our forecasts show a return to healthy levels of import and export growth at 8.9% and 7.2%, respectively. This growth is largely a result of Xi Jinping’s political reforms: there has been a formal recalibration of China’s economic priorities away from traditional export-led growth towards greater domestic consumption. While crackdowns on corruption will reduce factional power struggles and ensure party policy is more consistent – crucially in the area of foreign and security policy.

However, Xi’s pivot away from the notion of individual prosperity towards a collective sense of Chinese greatness has been characterised by growing economic and political nationalism. This manifests itself in regular military posturing – particularly in the South China Seas. Some regional powers see China’s behaviour, specifically the construction of factories across the Nine-Dash line, as an attempt at a land grab. Last year Vietnamese and Chinese vessels came to blows and there is an ongoing arbitration dispute with the Philippines. Sino-Japanese relations are also strained over the Senkaku/Diaoyu island dispute. There will be no easy solution to these problem and we expect it to rumble on throughout 2015.

The biggest risk to China is perhaps that it is alienating itself in the region and therefore inadvertently aiding their main rival: the US. At Delta we are already seeing evidence of this trend in our forecasts with rates of US total trade growth to the Asia Pacific region set to jump from 2.7% in 2014 to 4.2% in 2015.


Russia and China may emerge as strong economic partners  |  It is unlikely that China will curb its military spending or industrial production in the near future. Chinese demand for energy is huge in China and, after the Ukraine crisis, it appears China has found a key partner to meet its burgeoning demand for oil.

We expect a significant increase in trade between the two nations. Bilateral trade growth was a paltry 0.7% in 2013 but 9% in 2014; this is clearly indicative of a booming relationship. This has been epitomised by recent deals such as the Gazprom-CNPC contract which is worth an estimated $400 billion. As well as the recent Vankor pipeline deal, referred to by Putin as “the biggest construction project in the world”. The Vankor oil project is estimated to be completed in 2019; a sign of Russia’s long-term commitment to trade with China.

So, although 2015 is unlikely to see any catastrophic bust-ups between the world’s major powers, tensions are certainly simmering. If there is one factor which has the potential to be the proverbial “straw that breaks the camel’s back” it is oil. Russia is also deepening ties with oil-producing Latin American countries. Russia, of course, has little need of oil itself and is clearly attempting to undermine US interests. Oil trade may well turn out to be a metaphorical battleground as the year progresses.


Dragons and Eagles and Bears, oh my! Geopolitics among global powers  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Pour Oil on Troubled Waters

There is no reason to think the oil prices will not go down further given the current state of affairs. We are entering unchartered territory and, looking at our estimates, it is very likely that the price of crude will bottom out at $40. Indeed, most commentators point squarely at supply (or over supply) rather than demand deficiency as a main driver for the spiralling prices.

Whilst the US remains the largest producer (and consumer) of crude, in terms of international trade, Saudi Arabia was the largest exporter of crude in 2014 and is forecast to reign at the top spot in 2015. Delta Economics forecasts world crude exports to take a hit in 2015 with a -1.28% reduction in exports on the previous year (2014). As global demand continues to dampen because of weak economic activity, oil exporters such as Saudi Arabia are responding by slashing prices to the EU and US yet increasing them to Asia. This is understandable given the inelastic nature of crude. Indeed it seems Saudi Arabia is more willing (and able) to absorb potential losses because it accumulated a generous buffer when prices were high. Qatar and Kuwait, too, are better poised than producers such as Venezuela, Iran and Russia, all of whom are experiencing budgetary strains – some small (Russia), some large (Iran), with one, Venezuela, facing imminent default unless China, the largest crude importer, steps in to negotiate some kind of agreement. OPEC nations agreed last month to maintain production at their usual level, whilst non-OPEC producing nations have stoked up their capabilities, which helps drive down the price of crude even further.

The Shale Revolution on the other hand is helping the US wean itself off its dependency on international crude. However, as reports have shown, the extraction of Shale is only viable if oil prices remain high: lower prices are only adding pressure to Shale producers’ business model. But let’s not forget that lower oil prices are also great news for the largest importers of oil such as US, India, China and the EU, all of whom are experiencing an unintended windfall that is likely to be passed on to the consumer in the months to come.



Figure 1
 |  Pour Oil on Troubled Waters
Source  |  DeltaMetrics 2015


Pour Oil on Troubled Waters  |  Author  |  Shefali Enaker  |  Economist

Webcast 026 | Trade and economic outlook 2015: the Delta Economics view

Delta Economics CEO Rebecca Harding examines some of the main trade trends and challenges expected in 2015. Looking at issues such as disinflation that continue through from 2014, this Webcast discusses how much trade may grow this year and looks at some of the key countries and sectors that will be driving trade. The impact of continuing instability from geo-political tensions in the Ukraine and Russia as well as Syria and Iraq is also outlined with a view to understanding their likely impact on the global trade environment.



Webcast 026 Author  |  Rebecca Harding  |  CEO

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 022 | Cold Turkey

Delta Economics’s Q1 forecast of 5% trade growth in MENA has been hit by a deteriorating geopolitical situation. Uncertainty will hurt markets and places Turkey’s growth in a fragile position.



Webcast 022 Author  |  Rebecca Harding  |  CEO

The invisible hand

Why Argentina needs free trade more than ever  |  There is little doubt that Argentina needs a miracle, or at least a helping hand. No, this is not another reference to football: just a simple statement of fact.

It has until the 30th July to find USD 1.3bn in order to avoid default. Argentina’s trade performance has suffered as a result of poor economic and trade tariff management since 2011. Trade declined in 2012 by over 4% and while it grew in 2013 and is expected to return to growth of around 7% this year, this will only take it back to the levels of exports last seen in the middle of 2011. Policy makers have focused instead on attracting inward investment to develop the large shale gas reserves, taking their eye of the trade ball. Yet even this policy has stalled: Delta Economics is forecasting that Foreign Direct Investment levels will increase in 2014 but this will again only take them just above the 2011 levels. Put simply: if Argentina is to stave off the permanent threat of default and encourage enduring FDI, it will have to bring the invisible hand back into its trade markets.

At first glance, it does not appear that trade matters unduly to the Argentinian economy. It still runs a trade surplus, although not as substantial as it was and this is reflected in its positive terms of trade (the value of exports in relation to the price of imports). Yet there appears to be very little correlation (-0.37) between its terms of trade and the value of the Argentinian Peso (ARS), as illustrated in Figure 1.


2014-07-07_the InvisibleHand_fig01

Figure 1  |  Argentina’s terms of trade vs ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


This matters in so far as countries with high correlations between trade and their currency values are less prone to speculative attacks on their currency. The Peso has weakened by around 50% since the financial crisis: the last time the deterioration in its value was as substantial, Argentina was gripped by its last sovereign debt crisis. While the decline in value has been over a longer period of time, it does suggest that traders are speculating against Argentina being able to re-pay its debt.

If this is the case, then it is more than worrying. Argentina needs to default on its debt a bit like its football team needs the Netherlands to score 2 goals in the first fifteen minutes of the game on Wednesday. If it defaults, then it will find it very difficult to raise the external capital/inward investment that it needs to begin the process of extracting shale gas. But as Figure 2 shows, Argentina is no longer a net exporter of oil and gas, so, in order to restore its self-sufficiency urgently needs this inward investment.


2014-07-07_the InvisibleHand_fig02

Figure 2  |  Value of Argentina’s oil and gas trade (USDm) versus ARS per USD, Last Price Monthly, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


The Peso is barely correlated with oil and gas exports (-0.42), although it is correlated with its imports (0.72) suggesting that as the currency weakens (values are in Peso per USD), it is more likely to import oil which is worrying because it suggests that oil imports are plugging a structural weakness in Argentina rather than a response to imported oil being proportionately cheaper. And as the correlation with exports is so weak, it reinforces the view that the currency is more closely correlated with its economic condition than with its trade position.

So what is the scale of the challenge ahead? What does the Argentinian government need to do if it is indeed to create substantial economic growth through the inward-investment associated with shale gas production? Figure 3 presents the specific six-digit subsectors within natural gas that represent shale.


2014-07-07_the InvisibleHand_fig03

Figure 3  |  Value of Argentina’s natural gas imports and exports (USDm), 2001-2026 (forecast)

Source  |  DeltaMetrics 2014


Other things being equal, that is, if inward investment continues at the pace we are currently seeing it and if policy and the economic climate remain unchanged, then the picture is not rosy for Argentina’s shale gas revolution. Our model suggests that imports are already outstripping exports and that trend will continue to grow over time. The chance of a trade surplus is remote, as is the chance of self-sufficiency in gas.

It is not the intention to enter a debate on shale in Argentina, still less to suggest that this is the only way out of the current crisis. Instead, just take a look at where policy really can have an influence: trade. Argentina’s openness, in other words its trade as a proportion of GDP has grown from just under 30% in 2001 to over 60% now. The economy is more dependent on trade as a result since it is so important in relation to GDP.

Yet oil and gas is not the sector, arguably, where it should be focusing in the short term. There are two reasons for this. First, the normalised revealed comparative advantage of oil and gas has deteriorated from a position where it was competitive in 2001 (0.39) to a position where it is uncompetitive now (-0.51). We are expecting its position to deteriorate still further to -0.60 by 2020. In contrast, Automotives were uncompetitive in 2001 (-0.12) but are competitive now (0.32) and will be more so by 2020 (0.38).

Second, there appears to be a much stronger correlation between automotive trade and the value of the currency suggesting that some of the speculation may dissipate if the manufacturing side of the economy can be allowed to flourish as Figure 4 shows.


2014-07-07_the InvisibleHand_fig04

Figure 4  |  Value of Argentina’s automotive exports overall and to Brazil (USDm) vs ARS per USD, June 2001-June 2014

Source  |  DeltaMetrics 2014, Bloomberg


If Argentina can grow its manufacturing sector then it stands a chance of creating real export-led growth, particularly if it focuses on the regional automotive supply chain to Brazil since the correlation between it and its currency is particularly high for that trade route. As the currency has weakened, this has strengthened the position of Argentina’s automotive sector in relation to Brazil and has provided a platform for growth.

This is where policy makers should focus to address the challenges of growth and currency stability in the long run and to provide a clear message to markets and arguably the US Supreme Court to stave off default in the short run. Trade suffered between 2001 and 2012 when tariffs were first imposed and Argentina can in no sense afford to make this mistake again. Free trade is as key – otherwise the “hand of God” may well start to look like an Argentina own goal.



Oil spill-overs

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

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

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



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


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

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

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



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


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



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


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

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

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


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


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

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

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


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.