Reliefpostponed,TurkishLiraandModelproblem

In our notes one topic which gets mentioned invariably every day is uncertainty. Some days we write that the uncertainty has increased leading to a particular market reaction, notwithstanding that on other days the same market reaction can result even if uncertainty has reduced. There are two parts to this problem. The first one is the causal problem. Market reactions are hardly due to one singular piece of information. There are myriads of inputs going on simultaneously, hence concocting a perfect causal chain is more a case of post facto force fitting. Take this example of the statement “Oil rose because of low inventory data published in the US.” Things are mostly not so simple.

The second part is the imperfect understanding of the underlying process (in case there is one process!). So not only the input and output variables but the process connecting them can also change and undergo a shift. In hard sciences like physics, this is not the case, but in the case of economics, which is a social science, having absolute beliefs can be faulty as well as dangerous. This problem can be called the Model problem. For example the belief that high liquidity will lead to high inflation has been debunked by the evidence in the developed economies where 12 years of low rates and ample liquidity have still not produced any inflation. This reflects that the underlying process which connected liquidity with inflation has morphed into something else. On the other hand, in the emerging economies this effect remains more or less true even now.

Now we started on the point of uncertainty today. One development which can be classified as lowering the uncertainty is the news that the US corona stimulus package is now surely not going to come before elections. So the timing uncertainty is gone. But then we know that as anything goes deep into the future, the probability of it getting impacted by more uncertain events in the future rises. The relief package will now be decided by a new president and a new look HOR and Senate. So one kind of uncertainty has been traded for another.  The Dow Jones fell by 0.8% by the close yesterday and today US futures have opened in red in the Asia trade.

News that there is going to be a second phase of widespread lockdowns across some countries in the EU (especially France) has also added to the feeling of gloom. US, Russia and France have all witnessed a record surge in new cases in the last few days, prompting the authorities to respond by lock and curb measures. We will have the ECB monetary policy meeting tomorrow.

As we enter into the final week of the US presidential election campaign it appears that markets would prefer taking a risk off approach. The US elections are a close race and predicting results is tricky given the complexity of popular votes and electoral college complexity. It is important to acknowledge that going into such a high impact binary event participants would do well to wind their risky bets. The dollar index, Yen and gold should appreciate with US yields coming down. The US 10 year yield which was 0.85 last week is trading at 0.77 currently. Gold trades around 1905$/oz.

In other news, the Turkish Lira has now jumped to life time lows beyond 8.1 against the dollar. The growing tensions with the EU, military issues in the neighbourhood and rising inflation have all been touted as plausible reasons. Earlier the Turkish Central bank dashed the expectations of a rate increase which resulted in folding of some of the foreign money. It is important to recall that in August 2018, when there was a sudden drop in TRY, it was the trigger point for lot of EM currencies to follow suit. This time round though the problems appear mostly domestic.