Signaling,OperationTwistandNateSilver

Some time back we had written about the yin and yang analogy of hope and despair or risk on and risk off. The point was that the two reside in constant embrace and it is difficult to untangle them. The markets also reflect this, sample the 700 point fall in the Dow Jones on Friday and 500 points rise yesterday. The constant stream of news flow keeps the risk on and risk off traders always on the edge. One day it can be the news about the increasing virus numbers and the doubt on the reopening efforts and another day it can be the good housing data which can reignite hope again.

Yesterday the US pending home sales increased by 44.3% in May as compared to April according to the National Association of Realtors. This is the largest one month jump in the history of the survey. As per the analysts this robust rise signifies consumer confidence in their future earnings (read economic recovery). Homeownership has always been held as the cornerstone of American consumerism. Now readers would do well to reflect that how, with great frequency, different data sets emerge and point toward a completely contrary future outcome.

Author Nate Silver in his 2012 book The Signal and the Noise tackles the same quandary at length. How to chaff signal from the noise amidst the deluge of structured and unstructured data in which we live. Silver states that the human race is hard-wired to find patterns in available information even if there are none. He takes us to the human evolutionary history stating that for initial 1.5 million years of human existence, the homo sapiens were neither the fastest nor the strongest of the mammals. To survive the human race was solely dependent on their ability to make sense of the surroundings and here they developed the faculty of pattern recognition. In the current epoch of information in which we are living (he has a date for the start of this epoch, AD 1440, and we will discuss the reason for this in a later note), Sliver says that it is becoming increasingly easy to find patterns but it is difficult to ascertain whether those patterns are actually signals or useless noise. For example the home sales data could be interpreted as suggesting a V shaped recovery or it could be just the clearing of inventory at extremely low price levels. It is  hard to discern.

On the domestic front, the RBI came back with the Operation Twist redux where the central bank will sell shorter dated bills and buy longer dated bonds. The notified amount for both legs will be 10k Cr INR. Now given the small size of the operation amount this is a “signal” which the central bank wants to give that they are looking to address the issue of curve steepening. The 10 year bond opened at 5.87 against the previous closing of 5.91. Market participants would now look for the next steps from the RBI to see whether it will be more of operation twist or outright purchase. This remains to be seen.