DowJones,DollarIndexandFed'sbalancesheet

The Dow Jones had another good day in the office with a 2% gain yesterday. The primary comforting news was on ADP private payrolls data which showed a drop of 2.76 million against the expectation of 8.75 million helping the belief in economic recovery. The Dollar Index has also continued its fall to trade around 97.30 levels. As the mantle of the world’s reserve currency sits with the dollar, the dollar decline indicates that the smart money is now comfortable in moving to other currencies (read higher yields) and is not looking for the safe haven appeal of the dollar. During the crisis moments in March, the USD Index had run up to 103. One more fact which has contributed to the decline in the dollar index has been the aggressive Fed actions.

When we say aggressive it is the relative aggression which the Fed has shown against the other developed market central banks. The Fed’s balance sheet has grown 70% versus 18% for ECB and 8% for BOJ. The Fed balance sheet size currently stands close to 7.1 trillion USD against the Feb level of just above 4 trillion USD. In 2008, just before the global financial crisis, the balance sheet size was at 1 trillion USD post which the QE 1,2 and 3 took it to above 4 trillion USD in 2014. We all remember that just the discussion about tapering it down in 2013 sent the world assets into a tizzy and the all-important phrase “taper tantrum” was born. The actual contraction of the balance sheet later met a very hostile reaction in stock markets and was one of the most contentious issues between the US President and the Fed chief. 

Now as the stock markets rise every day, it is advisable to study the money supply impact here. Let’s look at the theoretical construct here referring to the ECO 101’s cardinal equation MV=PY. An increase in M with constant V should lead to either increase in output (Y) or increase in inflation (P). But what if the excess money supply doesn’t actually reach the economy and ends up getting invested in a particular asset class by the economic agents. In that scenario, that particular asset classes would witness inflation (aka bubbles) rather than a generalized economy-wide inflation. The problem with such bubbles is that it is difficult to identify a bubble early as one can’t discern whether it is due to genuine demand increase or just the money supply phenomenon. This can also be seen as the ever present quintessential Wall Street vs Main Street paradox.

 In other important news for the day, the ECB is expected to take a call on increasing the PEPP program by another 375 billion Euro. The Euro currently trades at 1.1210, its highest level since March. The risk off harbinger Japanese Yen is down to 109 in today’s trading. 

The Indian rupee currently trades at 75.53. The Nifty trades slightly in the green around the 10000 mark. Gold trades at 1704 $/oz whereas Brent Crude trades around 39$/bbl.