ImprobableeventsandNovakDjokovic

At the start of 2020, if some one had asked us the questions like which country will come at the top of the medals tally in Olympics or who will be the winner in Wimbledon, our primary source of answer would have been the past medal tally for the Olympics and the past winner or the current top seed for Wimbledon. Nobody in their right mind would have said that there is a possibility that we will see cancellation/postponement of both events. Similarly for the global market queries we would have spouted benign answers on inflation, growth, interest rates and central bank balance sheets. Numbers like 24% contraction (for India GDP growth) and 7 Trn USD (Fed’s B/S) would not have formed part of any answer. It is key to understand that the probability of occurrence of wildly unexpected  events is much higher than what our inductive models (learning from past experiences) would like us to assume.

Further on the sports analogy, the event yesterday where Novak Djokovic was booted out of the US Open because of intentionally/unintentionally hitting a linesman was an extremely improbable event. That it happened in a year when the major sporting events have already been cancelled makes it look much more extreme. In the context of markets, the point here is that the economy, which is already facing the covid shock, shouldn’t be complacent.  US elections might go down the wire and one party might refuse to accept the result, a hard Brexit might happen even after 4 long years of negotiations, an Indo China tension might build into something bigger than just a scuffle – all these are low probability but still possible. We never know that due to these events the economy might end on a mat holding its throat like that unsuspecting linesman during  Novak’s match. A V-shaped recovery might turn into a W and W might turn into an oscilloscope, one never knows.

But then what is the actionable outcome of all this philosophical spiel? Simple - protect the downside. For example, the Indian rupee has come to 73.20 levels from 75 in a fortnight, importers can buy a 75 Call at much reduced prices now.

Returning to our global markets round up. US markets were closed on account of Labor Day. Addressing a Labor Day conference at the White House, the US President talked about decoupling the US economy from China and explained the meaning of the word in simple terms too. “We do business with them and lose billion of dollars and if we didn’t do business with them we wouldn’t lose those billions. It is called decoupling.” Across the Atlantic, the news on Brexit was not too positive as the British side indicated that they will step preparation for a hard Brexit. The pound sterling was last trading at 1.3140 against the level of 1.3350 five days back. In Japan the possibility of a snap election is rising amidst the sober news on the Q2 GDP front.

Domestically, the bond markets experienced a volatile day yesterday. With the 10 year benchmark yield rising to 6% from 5.94% and then coming back to opening levels. Unconfirmed news during the day that government might breach the 12 lac crore borrowing mark made the markets jittery. The 12 lac crore number had come somewhere during mid-May. Post that we had seen the analysis in the RBI’s annual report where they contended that the situation has been worse than anticipated. The late rally in yields was attributed to the security announcement for the second tranche of OT. Both bonds and the rupee have opened down today - 6.02 on 5.77 2030 and 73.58 on the rupee. The news on the northern border might be in play.