Mt30kandtheriseinEuphoria

The Dow Jones scaled the peak of Mt 30000 in yesterday’s trading. The dollar index is trading close to the 92 mark which is close to its lowest level since early September. Gold is down towards 1800$/oz levels. US 10 year treasury is running close to 0.88 up from 0.82 last week. Crypto currency prices are rising and are hovering around some giddy all time high levels. EM currencies are in a tearing hurry to appreciate. South African ZAR and Mexican Peso both have risen by 9% since October start. Calling the current rally as an innocuous “risk on” will be an understatement.

So what is the possible explanation around the immediate optimism? The change in the guard in the US was already evident by Nov 4^th when the results came in. Though there was some scepticism regarding the legal challenges but a down right overturning of results was never the base case scenario. Hence we can trace the euphoria to the vaccine news which started trickling in last week with three vaccine makers coming up with heartening late stage trial results. Even if one maker has the probability of failure of let’s say 10% (a hypothetical number), three independent manufacturers all failing will have the probability of .01 to the power 3. This makes any eventual gloom on the vaccine front a highly unlikely event. The second source of optimism can be traced to the choice around the new Treasury Secretary Janet Yellen. Her tenure as a Fed Chief which saw no hike and a protracted accommodative stance for four years is being parsed by the analysts to deduce her upcoming role as treasury secretary. The size of the stimulus hence can be seen tilting towards a higher number. Also the recent speech by the President elect that the US is set to re-embrace the role as the leader of the world making a departure from the America First policy of the last government, indicates a world which is more predictable and less chaotic (no value judgement here). If markets love anything on par with high liquidity it is less uncertainty. Hence the euphoria. The signs on the Brexit front are also positive.

Now having explained the reasons of rise (with due benefit of hindsight) one should tackle the question of what happens next. The most likely scenario which emerges now is that rates are expected to remain low. As per the Fed funds futures traded on CME it suggests that until 22 January no rate hikes are on table. CBs will likely continue with their asset buying spree and other support programs. Inflation at least in the developed world is slated to be lower than the target rate of 2% for some time to come.

Inflation generally is closely linked to the unemployment rate in the economy, as any economy which reaches the full employment level gives rise to wage hikes which then feeds into goods and asset price inflation. As the economies are not expected to reach anywhere near the pre pandemic levels of employment any time soon, any rise in inflation looks further away. Some jobs may be structurally gone forever. For the developing economies, the equation is not so simple as they are much more vulnerable to supply side shocks. There the rate hikes can come early.

In India we will have the GDP figure for Q2 coming out on Friday. Estimations range from -6% to -11%, post which we will see the MPC committee decision next week.