USElections,RafaelNadalandProbabilisticThinking

If someone had asked you how probable was Rafael Nadal’s victory in the French Open final yesterday, what would have been your answer? Looking at the past record (or the betting odds) one could have come up with an answer like 90-95%. This response is in the high probability zone which essentially conveys that any other outcome would have been highly surprising but still there is a sliver of a chance that it would have happened. Now the result of the French Open final is a binary event which presents itself with a neat yes or no in a post facto scenario.

A similar event, but of a much larger consequence, is going to be the US presidential election next month. Nate Silver, whom we had introduced as a the author of delectable book The signal and the noise, is in the business of election forecasting. After having correctly predicted the 2012 elections, in 2016 he gave a 72% chance to a Hillary win and he was excoriated post the results. But readers would do well here is to think whether he was wrong. A 72% probability of something happening also points to a 28% chance of it not happening. This judgement issue is very pronounced in infrequent binary outcomes. The correct interpretation of probabilistic estimates is given in Silver’s book itself. Let’s understand by an example: a 70% chance of rain tomorrow means that rain may or may not happen but over 100 days on which we forecast chances of rain, if our forecasts are good, it should rain on 70% of them and be dry on the rest. You would do well to carry an umbrella with you are given that forecast.

Now how does all this relate to global markets? The markets are assimilating and reconfiguring themselves on each and every forecast. The players can’t wait for the event to play out and then enter. They need to position in anticipation but make the bets keeping in mind the risk (less probable event happening) at the same time. If a win by one player is expected to strengthen the dollar, roll out tax cuts and greater stimulus relief, the bets need to be rolled out accordingly. If another’s win portends relief on trade wars, Yuan appreciation etc then the bets will take another form. Readers would do well to appreciate that the asset markets (equities, bonds, gold) are constantly updating these probabilities with every news item and it reflects in the price levels.

After having had our fill of philosophy for the day, let’s turn to the markets. Stocks are up, convinced that the stimulus is not an if but only a when debate. The euro and sterling have both gained trading at 1.1820 and 1.3040 respectively. Maybe the orderly Brexit is in vogue again. The yuan has unwound some of its recent gains as the Chinese central bank scrapped a requirement for reserves to deal in yuan forward contracts. This signals some discomfort by the authorities against the recent appreciation of the Chinese currency.

Domestically, the bonds have opened steady after the significant upmove on Friday post the policy. The 10 year benchmark bond trades around 5.9350. The WSS report released on Friday shows that the RBI Fx reserves have increased by 3 Bn USD to reach 545 Bn USD last week. The rupee opens around 73.13. Lastly Silver forecasts on his website (fiverthirtyeight.com) that the current election is 85:15 in favour of the Democrats. One has to decide how to prepare for the binary event, with an umbrella or a sun screen?