Russia Shocks The Markets: Fundamental And Algorithmic Analysis

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Includes: CNY, ERUS, EUO, FB, FXE, OIL, RBL, RSX, RSXJ, RUSL, RUSS, UUP
by: I Know First Research

Summary

Russia raises the key interest rate by 6.5%.

Is the crisis over for the US? Dollar is rising against the Yen, Ruble, and Euro.

Why the recent talk of the US dollar being replaced as the reserve currency is unrealistic.

Future forecast for USD/RUB, USD/JPY and EUR/USD by I Know First State of the Art predictive algorithm.

Russia raises interest rates by 6.5% over night.

Bank of Russia's Board of Directors decided to increase the key rate to 17% per annum on December 16th, 2014, the most drastic increase since the 1998 currency crisis. The increase will see the rate jump 6.5% from the previous rate of 10.5%. According to the bank the "decision was driven by the need to limit significantly increased devaluation and inflation risks".

In a surprise move, according to the bank interest rate policy loans secured by non-marketable assets or guarantees for a period of 2-549 days (from 16 December, 2014) will have a floating interest rate. The rate will be derived from the key rate of the central bank plus 1.75 percentage points.

Figure 1: Bank of Russia's key interest rate.

The move will cause many USD/RUB longs to money. The reason many people bet on the USD (NYSEARCA:UUP) is its consistent growth in recent times, especially against the ever weakening Ruble, which seemed like a sure bet.

Is the crisis over? The US dollar is rising against the yen, ruble, and euro.

Various factors caused the US dollar to increase this year. The dollar index reached a five-and-a-half year peak. Recently the euro (NYSEARCA:FXE) reached a two-year low against the dollar, as recent reports have signaled that the region would only see marginal economic growth in the fourth quarter. Research group Markit reported that the region is only on pace to see 0.1% GDP growth for the fourth quarter. The Japanese yen (NYSE:FXY) recently fell to a seven-year low against the dollar, caused by an ever declining economic growth, causing concerns about Japan's economy potentially falling into a recession. Partially at least, this is caused because of concerns over the stability of the current government, headed by Mr. Shinzo Abe, exerting downwards pressure on the currency. The Russian economy (NYSEARCA:RSX) is also struggling because of a sanctions standoff with the West amid rising tensions over Ukraine. With recent declining Oil prices (NYSEARCA:OIL), Russia's dependent economy will suffer, as will their currency. For the first time since 2009 a Brent Crude oil barrel is traded under $60.

Figure 2: prices if a Brent Crude Oil barrel. Source: Nasdaq

Why the recent talk of the US dollar being replaced as the reserve currency is unrealistic

Two factors currently make the US dollar maintain its long tradition of being the world's "reserve currency". First of all, it is "deep". Essentially, depth refers to the size of an order needed to move the market price by a given amount. In the case of the USD, this amount is so large that investors don't need to fear a speculative buy or sell attacks on the dollar. The only two currencies that could compete with the US for depth is China's yuan (NYSEARCA:CNY) and the euro; however, China's regulations on currency, and Europe's structure (every country has its own interest rates) (NYSEARCA:EUO) make them less applicable to be a reserve currency than the dollar. The next factor, liquidity, is also very important. Instead of talking directly in numbers just imagine the network effect. Because the US is currently the world largest reserve currency it is also constantly bought and sold. This by default makes it the most liquid, and to become more liquid a country would have to become the largest reserve currency; however, they can't do that because their currency currently does not offer the same liquidity. The two factors in combination create a shield wall which is very hard to break, yet not impossible. Irresponsible fiscal and monetary policy is alienating investor preference towards the USD. In terms of the network effect, they don't want to use Facebook (NASDAQ:FB) as their number one social network (reserve currency), but they stick with it because all their important friends are there (depth & liquidity).

However, this is the reason the US policies are out of control, they can afford it. The only thing keeping US securities at such a low interest rate is the world's demand for them. Currently about 30% percent of US debt outstanding is owned by foreign countries in their currency reserves. Without this the US would not be able to sustain its borrowing for very long. Recently, global factor led to the rise of the dollar, after some concerning years.

Algorithmic Analysis

I Know First is a financial services firm that utilizes an advanced self-learning algorithm to analyze, model and predict the stock market. The algorithm produces a forecast with a signal and a predictability indicator. The signal is the number in the middle of the box. The predictability is the number at the bottom of the box. At the top, a specific currency pair is identified. This format is consistent across all predictions.

Figure 3: Sample of a currency forecast from currency-prediction.com

The signal represents the predicted movement direction or trend, and is not a percentage or specific target price. The signal strength indicates how much the current price deviates from what the system considers an equilibrium or "fair" price, this applies always to the first pair, in this case the USD. The signal can have a positive (predicted increase) or negative (predicted decline) sign. The heat map is arranged according to the signal strength with strongest up signals at the top, while down signals are at the bottom. The table colors are indicative of the signal. Green corresponds to the positive signal and red indicates a negative signal. A deeper color means a stronger signal and a lighter color equals a weaker signal.

The predictability indicator measures the importance of the signal. The predictability is the historical correlation between the prediction and the actual market movement for that particular asset, which is recalculated daily. Theoretically the predictability ranges from minus one to plus one. The higher this number is the more predictable the particular asset is. If you compare predictability for different time ranges, you'll find that the longer time ranges have higher predictability. This means that longer-range signals are more important and tend to be more accurate.

In our article "Currency Forecast: Are People Regaining Faith In The Dollar?" we analyzed all the algorithmic a fundamental reasoning behind the recovery of the dollar in 2014. The article elaborated on the psychological factors that kept the dollar low and the expected change in market perception. The Dow Jones FXCM Dollar Index (INDEXDJX: USDOLLAR) has since shot up by over 5%. A more recent 3 month forecast demonstrated the algorithmic perspective of the dollar against many other currency pairs.

Figure 4: Algorithmic forecast performance review from Nov 29th.

In the figure above, one of the currency pairs that was predicted over a three-month time horizon was the US dollar and ruble (USD/RUB). On August 29th, this currency pair had signal strength of 3.38 and a predictability indicator of 0.13. Since the dollar was listed first, this positive signal strength meant the algorithm was predicting that the dollar would become more valuable. In accordance with the algorithm, the dollar gained 35.99% on the ruble over this time period.

I Know First 1 month currency forecast

Figure 5: Currency Forecast from December 8th, 2014.

The State of the Art Algorithmic forecast from December 8th, 2014 predicts the dollar will continue to strengthen against the Russian Rubble and Japanese Yen for the next month, and decrease against the euro. This is indicated through the strong signals for the USD on the two bright green boxes (left two). The teal box (right) indicates a weaker signal of only 0.10 suggesting the euro will strengthen, but only mildly. This forecast is for the 1 month horizon.

Update 16th December, 2014: The USD/RUB has increased by 25% since the forecast. Historically increasing interest rates so sharply signals more risk than return, and so, we stand with the forecast and expect the USD/RUB to continue with the trend. Russia's current economy, declining oil prices, declining gold prices (Russia gold reserves are also becoming less significant, Tonnes: 1,094.7) and strong economic sanctions from the west signal towards a very weak Ruble, and very unstable economy in 2015.

I Know First Research provides information on how to read algorithmic forecasts and the most recent algorithmic predictive technology news.

I Know First Research is the analytic branch of I Know First, a financial startup company that specializes in quantitatively predicting the stock market. This article was written by Daniel Hai, one of our interns. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.