Stocks,privilegeandTriffin'sDilemma

The Dow Jones was up again by 1.7% in the trade yesterday. The S&P 500 also continued its rally and turned positive for the year, fully recouping its losses from the coronavirus-related sell off earlier in the year. As this comes close on the heels of the positive NFP report of last Friday it appears that markets are now fully convinced that a V shaped economic recovery is not far off. Contrast this with the medical reality of no vaccine solution available yet, and the rally looks even more fantastic.

As we are in the week of the FOMC meeting (June 9th and 10th), it is a sanguine acknowledgement that the credit for fast recovery primarily rests with the Fed which promptly provided unlimited dollars for the stressed sectors. The government’s trillion dollar package also helped. It is interesting to note that the US was able to do all of this without impairing its bond markets. In fact many people across the world rushed to the safety of the dollar. That is the privilege of being the reserve currency of the world. In this week’s policy, market participants will look keenly to see for how long and for how much the Fed looks to be dovish. Release of dot plots will provide an idea.

In his 2010 book, Global Crisis Recession and Uneven Recovery, former RBI Governor YV Reddy spends a great deal of time on the topic of the US dollar being the reserve currency of the world and the kind of exorbitant privilege which it affords the US. He laments that having accepted US as the sole supplier of reserve currency, the world has become beholden to US monetary policy. He writes that this gives rise to a phenomenon known as Triffin’s dilemma. The dilemma refers to a situation when there are fundamental conflicts of interest between short term domestic and long term international economic objectives for an economy where the national currency also serves as an international reserve currency. Now in the current situation too, the policy of untethered money supply in the US impacts the economies across the world as they would be required to insulate themselves when these extra dollars start hunting for yield. They will then end up creating reserves which will ultimately get deployed in US treasuries only. Mr Reddy also outlines a few solutions to change the US reserve currency status - we will discuss the efficacy of those solutions in a later note.

In other news, the optimism trade carries across the world’s stocks. Economic reopening also supports the crude prices as the brent crude trades at 41.25$/bbl. Gold prices moved up, after a steep decline, to trade at 1697$/oz. If the FOMC shows an extra dovish bias, this will support gold prices.

Domestically, the INR trades at 75.45 currently after opening at 75.51. The 10 year benchmark bond 5.79% 2030 trades at 5.78. The same bond had seen the cut off of 5.86 in Friday’s auction.