JacksonHoleandnewinsightonInflation

Stocks markets across the world, especially the US ones, are in a tearing hurry to reach new highs. Yesterday was no different with the S&P 500 up 1% and the Nasdaq up 1.7%. The one way movement can sometimes be puzzling to explain.  We had written some days back that any market setting is essentially an interplay between two opposite forces. Taking the motif from Chinese philosophy we invoked Yin and Yang as bulls and bears. The motif implies that nothing is permanent and no position is the fundamentally correct one. Hence any one way movement can be understood as the shifting of equilibrium position between the two forces. This shifting can be the result of a new insight or some fundamental change. In the current case, the fundamental change is the boom in technology adoption, which was always on the anvil but has been fast forwarded by the pandemic.

As we wait for Powell’s speech in the virtual Jackson Hole conference, the “new insight” argument given above also becomes pertinent. Analysts expect the speech to shed light on the Fed’s thinking related to inflation. Readers would recall from our earlier notes that the inflation question remains the most important question for central bankers. As a CB they can either change the money supply or the benchmark short term rates. The conventional economic theories propound that easy liquidity and low interest rates stoke inflation. Remember MV = PY, If M (money supply) increases more than the rate of economic expansion (Y), the rise in P (inflation) is inevitable. But experience from the past 10 or 12 years in the developed markets has challenged this theory. Even with easy liquidity and low rates, no inflation occurred and inflation undershot the Fed’s target consistently. Hence Powell might end up announcing that the Fed is going to keep the rates low and liquidity accommodative for a much longer period than previously expected. How this will impact the markets? it will be positive for equities, US bond yields would move left and the dollar index would move down. Emerging markets would also be beneficiaries of this largesse.

Domestically, the INR is now settling into a new range of 74-74.50 as we see lot of dollar buying at the lower levels. Yesterday a lot of paying was witnessed in the forward markets, especially at the far end (1y) counters taking the annualized hedging cost higher. The annualized premia now stands close to 4.35%. On the bond market side, the impact of  Operation Twist on the yields of the longer tenor bonds seems to have waned. The 5.79 2030 bond trades at 6.19 currently. The important data point on the anvil is the India Quarterly GDP data due to be released on 31^st Aug - the expectation is around a contraction of close to 20%.