Webcast 034 | Does Trade Finance drive Trade Growth?

Why has trade slowed so much since 2011? In our latest Webcast, we question the critical role of trade finance, arguing that its short-term outlook is not so good.

 

Webcast 034 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.

 

 

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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).

 

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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.

 

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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.

 

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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).

 

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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).

 

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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.

 

 

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.

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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.

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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.

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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.

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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.

Trade and the Ides of March

Why the tide might not be rising | The International Monetary Fund (IMF) published its World Economic Outlook last week under the title, “Is the Tide Rising?”  For anyone struggling with floods in the UK at the moment, this title is either a bad joke or a timely reminder of the fact that economic forecasting, it is said, is designed to make weather forecasters look good.

The IMF expects World GDP growth to be higher, at 3.7% during 2014 rising to 3.9% in 2014 and while it points out the downside risks to the recovery, especially in emerging markets, there is a distinct air of optimism about the forecast.

Yet world trade, and the World Trade Organisation’s (WTO’s) outlook for world trade, remains flat with no return to the multiples of GDP that were seen prior to 2011.  The last forecast that the WTO published for 2013 was that world trade would grow and their own Head, Roberto Azevêdo was last month expecting the actual numbers to come in lower than that calling its relatively optimistic forecast for growth in 2014, of 4.5%, into question immediately.

The WTO is being characteristically positive at the start of the year as illustrated in Figure 1 which shows the forecast against actual trade.  The figure for December 2013 is provisional and will not be confirmed until April 2013.  The annual peaks in the forecast are in the first quarter of each year – Spring Tides, maybe.

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Figure 1 | WTO forecast for World trade growth vs Actual growth: October 2011-January 2014

Source | DeltaMetrics 2014

The reason for the peaks in the forecast in the first quarter of each year are evident from a closer scrutiny of world trade data on a monthly basis, as illustrated in Figure 2.

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Figure 2 | World trade growth: 2001-December 2014, actual and yeay-on-year

Source | DeltaMetrics 2014

NOTE: Data is actual IMF data up to September 2013, is Delta Economics estimates to January 2014 and thereafter forecast

Figure 2 unsurprisingly shows the big year-on-year drop in trade in 2009, but it is the time after that, especially since October 2010 that helps us explain why the IMF and WTO are optimistic at the start of every year.  There are cyclical upticks in trade in each year in Q3 and Q1 which, when examined as part of a “Net export” effect in GDP forecasts, have a multiplier effect.  However, what is clear from the analysis of year-on-year changes in Figure 2, is that the momentum has been downwards (both actual and estimated) since mid 2011 and that the pattern of post-crisis trade is actually substantially different to pre-crisis trade.

The other reason why the WTO and IMF may be over-optimistic in their start-of-year forecasting is because of the seasonal volatility in China’s trade data presented in Figure 3. Each year, a major drop in Chinese trade, visible throughout the period between December and January is upwardly adjusted by March leaving the trend trajectory one of growth.  These swings have been particularly obvious since the financial crisis and although there are similar seasonal patterns in Germany, the US and the UK but the swings are less marked.

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Figure 3 | Selected Countries’ Export Growth, June 2001-December 2014

Source | DeltaMetrics 2014

Based on the IMF’s own data up as far as the end of September 2013 as these charts are, it is easy to see why Roberto Azevêdo might be cautious about trade growth in 2013.  However, historical growth is of interest only to economists attempting to establish the scale of the damage that is currently being done by the slow-down in world trade.

What is more worrying is that the lessons from past trends seem to be buried in the past as well and that more recent analysis of what is happening with trade is focused simply on a dogmatic assumption that world trade growth has to return to a multiple of GDP growth (often taken to be 2.5 times GDP growth) if the world economy as a whole is to reach an “escape velocity” growth.

Trade since the crisis exhibits different patterns, more volatility and much slower year-on-year growth than pre-crisis.  Evidence from sectoral analysis of trade suggests that this is because global supply chains are using local content to service local markets and that global regional analysis yields more insight into how this fuels trade within regions rather than between regions.  While trade between emerging economies, which is highly commodity focused, remains flat because of the current economic challenges they face, the effects of export-led growth will be limited.

The temptation is nevertheless to watch trade growth and assume that, if it picks up, it will lead automatically to an increase in GDP.  We can expect a market rally during March when, if past trends are replicated, the tide really does rise and Chinese trade data for Q1 is corrected.  While the Delta Economics’ forecast suggests only modest trade growth in 2014 at around 1.6%, and while this is substantially below the current WTO forecast, as Brutus said, “There is a tide in the affairs of men, which, taken at the flood, leads on to fortune.”  This may only be short-lived, and all forecasters (whether economic or weather) should beware the Ides of March.