USPCEdata,weeklybondauctionsandlogicofauniqueevent

US PCE data for the month of May was released on Friday. The headline number showed the YOY jump of 3.9% but the all-important Core PCE data also showed a 3.4% YOY increase. The core PCE data is the Fed’s target metric for policy formulation. The current framework which was rejigged last year follows an AIT philosophy. AIT is the TLA for Average Inflation targeting. Low readings in one period will be compensated by higher readings in another to average around 2%. Inserting the discretion of averaging period makes the data lose some of its signal strength but still the high readings on a consistent basis do stoke a lot of debate.

However, the biggest argument forwarded by Fed or BOE or ECB or any other central bank (take your pick) that it is “different this time round”. The devastation brought on by covid is so unique that it cannot be and should not be explained or compared to boom and bust brought on by normal business cycles. In normal times change happens gradually, economy shifts, new winners come, they become euphoric and then the bust follows. The government and the central bank in the meantime try to temper that euphoria (or despondency) through their counter cyclical policies and sometimes become the cause celebre for the eventual boom or bust. This time round the act of overnight closure of the world economy, its prolonged coma, cautious reopening and frequent relapses (read waves) are events unprecedented in nature. The disease (covid) and the medicine (ultra-accommodative policy) has changed the patient (world economy) itself. The only debate is how fundamental this change is.

What readers need to focus on are two things, one is increase in CB balance sheets across the world as it creates primary money which then multiplies in the banking system (fractional reserve). Second is ultra-low rates for a long time. Now both of these combined if they stay in vogue for a long time (for covid or whatever reason) will change the nature of the economy itself. It is difficult to see how it will be reversed when the normal times return. As during the policy reversal there will be pain and job losses, it is very much possible that there will be backlashes. As the political class will wrestle with much shorter timeframes for re-election, they will campaign that the time for “reversal” has not yet come. Former RBI Governor YV Reddy in his 2011 book, Global Crisis, Recession and Uneven Recovery writes specifically about the intermixing of monetary policy making with political expediency. He warns that political cycles and business cycles operate at different time frames. Any policy reversal of monetary accommodation hence will always be anathema for ongoing government. Hence it will create friction between CB and the government. Readers would note the developments in Turkey as a live example. All in all, easy policies once set in place are difficult to dislodge. It doesn’t matter if the starting event was unique like covid.

Moving on from PCE, this week will see the NFP number on Friday. Once NFP numbers come in we can combine both the NFP and PCE to discuss it in the light of the Phillips Curve which is the historical bedrock of economics combining the two. On the domestic side, Indian Rupee and bonds both will watch the crude prices alarmingly. On Friday the central bank decided not to sell any 10-year benchmark security during the weekly auction. The underwriting commission for the benchmark 10-year was sufficiently high at 23 paise prior to the auction. The 10-year has been hovering around 6% for close to 2 months now even withstanding the covid second wave and hawkish Fed. Whether it will budge in the face of high crude is what remains to be seen.