PCEdatainUSandsearchforactionable

Asian markets like Hang Seng and Nikkei have started the new week in slight red. Dow and S&P 500 closed on Friday in slight green not getting overtly impacted with the inflation data. Similarly, on the Dollar Index DXY and the US yields also the inflation impact was minimal only. DXY is trading around 90 and 10-year yield is at 1.59, mostly unchanged from Friday morning. US markets will be closed today on account of Memorial Day. Indian Rupee is expected to open around 72.40 levels.

In the past week we had touched upon multiple topics of macroeconomic interest like jobs, growth, inflation etc. One would be right in asking that after all the globetrotting discussion of everything under the capitalistic Sun, what is the action item. Knowledge is fine in its holy abstractness but ultimately it needs to be translated into a tradeable output. We won’t dismiss the observation as flippant. But the answer would require a philosophical digression into the meta discussion about the knowledge itself.

To start with let’s try to look at the data points from the US which we got during last week and see what best actionable we can derive (Why the US, ultimately it is a unipolar world and home for the reserve currency). Over the week we got initial jobless claims (down), new home sales (down), Core PCE (up more than expectation) and Biden budget (6 trillion per year spend, proposal for huge deficits). There must be many others like retail sales, new covid cases etc but we will stop here on these four for the purpose of sanity of discussion. Jobless claims going down means economic opportunities are getting created, new home sales going down can convey either the prices are getting unaffordable or people don’t want to spend a big fortune right now. Core PCE number for April at 3.1% represents that price rise is here. Finally, government’s spending plan will result in more debt burden going forward. Combine the four and we can say that the economy is doing good, it is opening up and issues related with growth like inflation are also getting visible.

Maybe as the next step one can create a neat mathematical model using the above stylised data points. Post which the actual historical data can be fed into the model and it can then gear up to present a prediction on a future path of Dollar Index and Interest rates. Readers should note that in their models they can use 20 other data points as inputs, the number four above is only for representation purpose. The model can then be back-tested econometrically on the past data to refine the equations further. Ultimately, we will get a model which will try to fit in all the relevant information and gurgle up a prediction. It will be a complicated model and fundamental to it is a simple premise that there exists a certain level of order and predictability in the world. The last statement is a bit of a problem. The cause and effects are not connected so clearly in the real world.

In his book The End of Jobs author Taylor Pearson introduces us to the Cynefin framework to understand how the world operates. As per the framework there can be four types of processes ie, obvious (cause and effect are tightly coupled), complicated (establishing cause and effect requires investigation), complex (cause and effect only clear in retrospect) and finally chaotic (no relationship between the cause and effect). Readers would understand that any model howsoever robust resides in the complicated domain whereas the real world operates in either complex or chaotic domains. The predictions presented by the complicated models can be true but that would be a lucky exception not a norm. A causal relationship which work at lower leverage levels might break down completely at higher leverages. High inflation might prompt a hike, but even higher inflation might bring a regime change, an event not captured in any historic series. These events are out of model’s scope. We recently saw what happened with Corona and how it altered the global economy.

Going back and summing up, a good job number or high PCE can prompt us to predict a hike in interest rates but sadly the cause and effect are not so clearly defined. The world is inherently more complex than what we imagine. However, markets exist where one can make the bets on future like Fed fund futures on CBOE for future US interest rates. Even if one can’t predict, one can take a bet!