Those masters of the unpleasant surprise – JP Morgan Chase, the unhappy leaders of the syndicated corporate loan market in mid recession have unveiled a new tool for predicting exchange rate movements. Since it is not April Fools’ Day, the Economic Activity Surprise Index (EASI) must be what the bank says it is: a tool which “helps predict short-term currency moves triggered by shifting expectations for the economy … captures shifts in growth perceptions by looking at the recent history of economic activity surprises from consensus estimates … quantifies economic expectations – investors no longer have to rely on a `gut sense’ to determine how economic sentiment will influence currency direction … [and] delivers regular FX trading signals.”
As Morgan points out, the use of economic fundamentals to predict near-term FX direction has come under increasing scrutiny in recent years. Rising volumes of data about global cross-border – much of that data supplied by custodian banks tracking the investment and trading activities of their clients – have weakened confidence in trade balances, interest rate differentials and such like as reliable guides to exchange rate movements. As Morgan adds, last year’s trade-weighted dollar performance brought this into sharp focus: US interest rates fell to 40-year lows, and GDP growth collapsed from 3% to 0%, yet the dollar surged by 7% on a trade-weighted basis.
JPMorgan says that by tracking the recent history of economic data surprises rather than looking at economic fundamentals, EASI captures shift in market sentiment about the direction of a currency much earlier. The bank hopes that combining EASI with existing tools – namely, the Liquidity & Credit Premia Index (LCPI) and Sentiment & Flow Index (SFI) – will help it hang on to clients.
The product is being launched initially in the US, where it is constructed from the past six weeks’ activity data. The firm extracts signals of perceptions, which can be used by investors to trade currencies. The index is updated after each key data release and immediately posted on the firm’s website and emailed to clients.
Using EASI signals, JPMorgan found that almost all large dollar drops in recent years have coincided with phases of pessimism as defined by the EASI. In fact, sell signals since 1996 have correctly called a dollar fall 57% of the time, buy signals have correctly called dollar rallies 67% of the time, and trading EASI signals would have delivered annual returns of 8.2% (with an information ratio of 1.55). The EASI does more than just predict the dollar, though. Given that the US is widely seen leading the global economic cycle, EASI signals also help predict short-term moves in a host of currencies, which are sensitive to global growth trends.
As an illustration of returns, so far this year, investors using EASI to trade a US$ basket would be up 1.2%; Euro/$ would be up 2.8%; and $/Yen would be up 1.8%. Further, risk-adjusted returns are improved substantially by combining EASI with JPMorgan’s other FX tools.